Understanding Drag and Tag clauses for Venture Capitalists: A Cheat Sheet for HealthTech Founders

As a HealthTech founder, you're focused on innovation, product-market fit, and patient outcomes. But when it comes time to raise capital, you'll encounter a crucial document: the term sheet.

This legal document outlines the terms of a venture capital investment, and within it, you'll find provisions that govern what happens when the company is sold. Among the most important are Drag-Along and Tag-Along clauses.

Understanding these clauses is vital because they can significantly impact your control over your company and your personal financial outcome. Here’s a cheat sheet to help you navigate them.

What are they?

Drag-Along Clause: This is a right for the majority shareholder to force the minority shareholders to sell their shares in the event of a company sale.

The "Why": A potential buyer of your HealthTech company almost always wants to acquire 100% of the shares to have complete control. The drag-along clause prevents a few small shareholders from "holding out" and blocking a sale that is otherwise beneficial for the majority. It ensures a clean and efficient exit for everyone.

Who benefits? Primarily the majority shareholders, which could be the VC firm (if they hold a majority stake) or a coalition of investors and founders. However, it can also benefit founders by ensuring a viable exit isn't derailed by a single dissenting shareholder.

Tag-Along Clause: This is a right for the minority shareholder to join in on a sale of shares initiated by the majority shareholders.

The "Why": If a majority shareholder (like a VC fund) receives a great offer to sell their stake, a tag-along right ensures that a minority shareholder (like a founder) isn't left behind with a new, potentially less desirable, majority owner. It gives the minority the option to "tag along" and sell their shares on the same terms.

Who benefits? This is a key protection for minority shareholders, including founders who may no longer hold a majority stake after several funding rounds.

Special Considerations for HealthTech Founders

Mission-Driven Exits: As a HealthTech founder, you may be deeply committed to the long-term mission of your company. A drag-along clause could force a sale to a buyer that doesn't align with your vision for patient care or product development. Negotiating a founder-friendly trigger threshold is crucial to maintaining some control over your company's destiny.

Regulatory & IP Hurdles: The value of a HealthTech company is often tied to its intellectual property (IP) and regulatory approvals (e.g., FDA, CE Mark). Ensure that the drag-along clause's terms don't put you in a position where you're forced to sell before key regulatory milestones are met, which could significantly undervalue your company.

The "Liquidation Preference" Trap: VCs often have a "liquidation preference," which means they get their money back first in a sale, before common shareholders (like you). If a drag-along is triggered at a low valuation, the sale proceeds might only be enough to cover the VC's preference, leaving you with nothing. Understanding how this clause interacts with liquidation preferences is absolutely critical for your personal financial outcome.
 
 Founder's Mindset

Think of these clauses as two sides of the same coin:

Drag-along is for the majority's protection, ensuring they can achieve a clean exit.

Tag-along is for the minority's protection, ensuring they aren't left behind.

As a founder, your goal is to make sure these clauses are drafted with your interests in mind. Never assume that the "standard" terms are fair. Take the time to understand them, consult with legal counsel, and negotiate for terms that protect your vision and your equity.

To discuss any of these points and how Nelson Advisors can help your Healthtech company, please email [email protected]