What Happens When Co-Founders Stop Agreeing on Anything
Two founders launch a tech company, split the equity evenly, and for years everything works. Then a serious disagreement surfaces — over product direction, a new funding round, or bringing in a new business partner. Without a pre-agreed exit mechanism, both sides remain locked into joint ownership of a company neither of them can run cooperatively anymore.
This is precisely the scenario that BMBY, Drag Along, and Tag Along mechanisms are designed to prevent. These are contractual tools embedded in founder and shareholder agreements, meant to determine in advance what happens when shareholders reach an impasse, or when one shareholder decides to sell their holdings. Without precise drafting, each of these mechanisms can turn from a protective tool into a weapon of leverage.
The BMBY Mechanism: A Forced Buyout at a Price the Other Side Sets
The BMBY mechanism (Buy Me Buy You), also known as a shotgun clause, allows one shareholder to approach the other and name a per-share price. The receiving shareholder must then choose between exactly two options: sell their shares at the proposed price, or buy out the initiating shareholder's shares at that exact same price.
The mechanism's core advantage is that it forces the offering party to price fairly — if the price is too low, the other side will simply buy them out cheaply. It is an elegant tool for dissolving a partnership when both shareholders are in comparable financial positions and each is genuinely capable of financing a buyout.
When BMBY Does Not Work
- When there is a significant gap in financing capacity between shareholders — the financially stronger party will always prevail
- When shareholders hold unequal stakes or unequal operational roles in the company
- When other investors exist outside the agreement and could be harmed by a sudden shift in control
Given these sensitivities, the agreement should include an advance notice period, a financing mechanism (such as installment payments), and a restriction preventing the clause from being triggered too early in the company's lifecycle.
Drag Along: When the Majority Sells, the Minority Must Follow
A Drag Along clause gives shareholders holding a pre-defined majority (for example, a majority of issued shares, as set out in the specific agreement) the right to compel minority shareholders to sell their shares to a third party, on the same terms agreed with the buyer.
This mechanism is especially critical in M&A transactions. A prospective acquirer typically wants 100% of the company, not a partial purchase that leaves minority shareholders outside the deal. Without a Drag Along clause, a single minority shareholder could block a significant exit transaction even where the majority of shareholders support it.
Required Protections for the Minority
- Identical sale terms — the minority shareholder should receive the same per-share price and terms as the majority, proportionate to their holding
- Full transparency regarding deal terms, including earn-out or escrow mechanisms
- A prohibition on invoking the clause to circumvent the duties of good faith and fairness owed by majority shareholders
It is worth noting that exercising a Drag Along clause in bad faith, or in a manner that harms the minority beyond what is necessary, may amount to oppression of minority shareholders under section 191 of the Companies Law, 5759-1999. Careful drafting of the triggering conditions is therefore just as important as including the clause itself.
Tag Along: The Minority's Right to Join the Deal
A Tag Along clause is the mirror image of Drag Along, but operates to protect the minority. When a majority shareholder sells their holdings to a third party, minority shareholders are entitled to join the transaction and sell their shares to the same buyer, on the same terms.
The mechanism prevents a situation in which a majority shareholder "sells control" and leaves the minority stuck as a partner to a new, unfamiliar controlling shareholder. For financial investors, this is one of the most basic protective clauses they will insist on including in an investment agreement.
Key Drafting Points
- Defining the trigger threshold — whether the mechanism applies to every sale, or only to a sale exceeding a specified percentage of shares
- An advance notice mechanism that gives the minority a realistic window to decide whether to join the sale
- The relationship between Tag Along and a right of first refusal (ROFR) — typically the ROFR is exercised chronologically before Tag Along applies
The Legal Basis: Contractual Design, Not Statutory Mandate
It is important to understand that BMBY, Drag Along, and Tag Along are not independent statutory mechanisms under the Companies Law, 5759-1999. They are contractual arrangements, originating in the shareholder agreement and often also anchored in the company's articles of association.
The Companies Law permits a company to impose restrictions on share transfers through its articles, provided those restrictions are properly adopted. When exit mechanisms are anchored in both the shareholder agreement and the articles, enforcement becomes considerably stronger, since a breach of the articles may also affect the validity of the share transfer registration with the Registrar of Companies.
Beyond that, Israeli courts examine the exercise of exit mechanisms both through the lens of the duty of good faith under the Contracts Law (General Part), 5733-1973, and through the fairness principles that govern relations between shareholders under the Companies Law, including the prohibition on oppression set out in section 191. In practice, this means that even a properly drafted mechanism may not withstand judicial scrutiny if it was invoked under circumstances designed to harm the minority beyond what was necessary.
Recurring Drafting Mistakes in Founder Agreements
Practical experience shows that most disputes over exit mechanisms do not stem from the absence of a mechanism, but from careless drafting of one. These are the most common pitfalls:
- Misalignment between the agreement and the articles — a mechanism that appears in the shareholder agreement but not in the company's articles can conflict with the articles when a share transfer is actually executed
- No clear valuation mechanism — particularly with BMBY, ambiguity over how the initial price is set, or over an arbitration process for disputes, creates significant delays
- Ignoring outside investors — a mechanism signed only between founders, without accounting for the rights of investors who joined in later funding rounds
- No lock-up periods — triggering Drag Along or BMBY too early in the company's life can undermine its operational stability
- Failing to address tax implications — a forced share sale may trigger a taxable event at a time that is inconvenient for the selling shareholder, and this should be reviewed in advance with a tax advisor
What Companies Should Actually Do
Exit mechanisms should be built into the shareholder agreement as early as possible — ideally at company formation, or immediately upon bringing in new partners or investors. Attempting to draft them after a dispute has already erupted between shareholders is almost always too late, since by that point the parties' interests are already opposed.
- Ensure full alignment between the shareholder agreement and the company's articles of association
- Establish an objective valuation mechanism, including an arbitration process for disputes
- Match the mechanism to the company's stage — BMBY generally suits early-stage companies with a small number of shareholders, while Drag Along/Tag Along remain relevant through later funding rounds as well
- Consider the interplay with ROFR mechanisms and the veto rights of existing investors
- Update the agreement at each significant funding round to ensure it reflects the current ownership structure
Well-drafted exit mechanisms are not meant to serve as a punitive tool against an unwanted partner. Their purpose is to prevent operational deadlock and allow the company to keep functioning even when shareholders no longer see eye to eye. A company that invests in precise drafting of these mechanisms early on spares itself painful negotiations and substantial legal risk down the road.
The information contained in this article is general in nature and does not constitute legal advice. For advice tailored to the specific circumstances of your company, we invite you to contact our firm.
