This provision will appear when there are multiple investors or multiple rounds raised, where the company doesn't want multiple investors to vote differently based upon the in whatever way the shareholders want. But rather want them to vote based upon Investing Class ( ie, Series A as a whole or Preferred shares as a whole). Let's look into it in more detail.
In the term sheet, there are 2 types of drag along agreement:
Preferred drag along
Common Drag Along Or Tag Along ( Most commonly used)
Here is a typical Drag-along in the term sheet:
""" Drag-Along Agreement: The [holders of the Common Stock] or [Founders] and Series A Preferred shall enter into a drag-along agreement whereby if a majority of the holders of Series A Preferred agree to sale or liquidation of the Company, the holders of the remaining Series A Preferred and Common Stock shall consent to and raise no objections to such sale."""
When dealing with selling off the business, the founders/investors should look at any liquidation preference the shareholder has, as it can reduce the take-away money from the founders. For example, if the company is sold for $1bn and the VC preference is $2bn with the liquidation preference intact, the $1bn will be taken by the VC, and nothing is left for the founder. So please look at this clause carefully. We will look into the topic more later.
What if the founder leaves the company, how will the shares voting be counted? To understand this, we need to understand what type of stock the founder holds, common stock or preferred stock ( founder's mostly owns common stock). Now if the company is set to be acquired and the common shareholders have voted as 90% "yes" and 10%"no". At this point, the departing founder's shares are voted according to this structure 90% "yes" and 10% "no".
Another Scenario is that an investor who owns very little shares (1%) of the company, and there are 30 investors with 1% shares in the company. So to prevent irrational consent by the majority shareholder who owns 50% of the company. The acquirer will want 85-90% consent so that the minority investors get their right to vote and their voice being heard.
Note: Most of the drag-along or tag along agreements are based on the common stock, not preferred stock. Preferred holders can convert their series A stock to common stock to increase their influence and which can reduce the liquidation preference given to the Preferred shares.
