Demistifying Term Sheets: Part 10 - Drag Along Rights

Negotiating a term sheet can feel like walking a tightrope, a delicate balance between ambition and protection for both entrepreneurs and investors. Every line of a term sheet carries weight, telling a story about the future of a business. Drawing from years of experience in the VC play, we are pulling back the curtain to highlight what really matters in a term sheet, how both sides should approach it, and the lessons we have learned (sometimes the hard way) to avoid common pitfalls.

In the spirit of transparency, we are sharing a copy of our full term sheet template here.

This article is meant to serve as a guide to navigating term sheet negotiations, highlighting the most critical clauses, and sharing tips for both entrepreneurs and investors. Our term sheet reflects how we do things differently. When our founders Gonzalo Martínez de Azagra and Igor de la Sota set up the fund, they did not just replicate existing VC practices, they built something that truly represents Cardumen Capital’s values.

That said, this guide is not set in stone; it is a living document that evolves as the market changes. But before diving into the details, here is an important starting point: a term sheet is not a promise to invest, in other words, it is not a legally binding document. Even when signed, it is not a guarantee of funding. Instead, it should be seen more as an agreement to keep negotiations private and, in some cases, to pause the company from exploring other offers for a certain period of time.

Now, let us get down to business. While every term sheet is unique, just like every investment offer, there are certain key terms that almost always come up in negotiations. Keep reading to learn what these are and why they matter.

Drag Along Rights

Drag-along rights are designed to streamline significant transactions, such as mergers, acquisitions, or the sale of the company. These provisions allow majority shareholders to "drag" minority shareholders to sell their shares or vote in favour of a transaction under the same terms. The goal is to prevent minority shareholders from blocking deals that could benefit the company and its stakeholders.

How Drag-Along Rights Work

Typically, if a majority of shareholders (often including specific groups like preferred shareholders) approve a transaction, minority shareholders are obligated to participate in the deal under the same conditions. Drag-along rights are usually structured to align with thresholds, such as a certain percentage of shareholders (i.e. 75%) agreeing to the transaction, ensuring it’s a fair and well-supported decision.

Additional Considerations

• Alignment across share classes: Many drag-along clauses require approval from both preferred and common shareholders, protecting all stakeholders.
• ‍Fair terms for all parties: Drag-along provisions ensure minority shareholders receive the same terms as the majority, avoiding potential exploitation

Key Takeaways

Cardumen Insight

We recognize that drag-along rights are most critical when things are not going as planned. They help ensure alignment and prevent holdouts during challenging exits, providing a path forward that protects the company’s overall interests.