Overview and Motivation
Typical shareholder agreements contain “drag-along” and “tag-along” clauses. If someone makes an acquisition offer and a majority of shareholders wants to sell, the drag-along clause allows them to force the rest of the shareholders to join them in selling their shares at the same price. This is useful because an acquirer often wants to either buy a company completely or not at all. This is similar to a squeeze-out on the stock market, which allows someone owning 98% of a company to buy the remaining 2%. In contrast, a drag-along clause is often already enforceable when 75% or so of the shareholders agree. However, enforcing a drag-along clause can be time consuming in practice as all involved parties need to be contacted, need to sign a transfer agreement, and need to be paid. Our draggable smart contract fully automates this process for tokenized shares, thereby allowing companies to have thousands of shareholders without losing the strategic option of an exit.
The ERC‑20 contract ERC20Draggable can be used to convert any existing ERC‑20 token (referred to as base token) into a draggable token by wrapping it. Once deployed, the contract offers the following functionality:
- Anyone owning base tokens can wrap them at any time, thereby converting these base tokens into draggable tokens. The base tokens still exist, but are now under control of the draggable contract. Think of this process as taking a traditional paper certificate and putting it into a sealed envelope. For each outstanding draggable token, the draggable contract holds exactly one base token as backing. A draggable token legally represents a base token that is bound to a shareholder agreement.
- A majority of shareholders holding 75% of the shares can update the shareholder agreement and migrate all the base tokens to a new contract that represents a different shareholder agreement or even end the shareholder agreement completely. Once the agreement has ended, token holders are free to unwrap their base tokens again – or to break the seal and open the envelope when thinking in terms of the paper analogy.
- Anyone can make an acquisition offer at any time. When doing so, the full acquisition amount must be available in a currency of choice (for example 10 million DAI, if the company is valued that highly). If a given quorum (e.g. 75%) of all votes cast within a given timeframe (e.g. 60 days) approve the acquisition, all base tokens are sent to the acquirer and replaced with the according amount of money. From now on, the draggable tokens do not represent a share any more, but the according amount of the acquisition currency (e.g. 100 DAI per token). Token holders are free to unwrap their DAI at any time. In the paper analogy, the shareholders can now open their sealed envelopes as the shareholder agreement has ended, but instead of finding a certificate inside, they magically find a bundle of bank notes.
- In case not all shares are tokenized, an external oracle can report the votes of the other shareholders to the token contract
- If the offer has expired or the offer is not well funded anymore, anyone can kill the current offer by calling
conteston the offer contract.
- When making an offer, a license fee of 3 Ether is charged. This has the nice side-effect of ensuring that the offer is serious.
- The person who made the offer can cancel the offer at any point in time.
- Counteroffers can be made, but the price needs to be higher than the previous offer and in the same currency.
- The offer can be ended early if it is clear that the remaining votes cannot make a difference any more.
A majority of shareholders could abuse the smart contract to acquire the shares of the remaining shareholders at a very small price by making a cheap acquisition offer and approving it. Doing so would likely constitute a violation of the shareholder agreement and the minority shareholder would have to hold the majority accountable using the traditional legal system. The assumption is that it is possible to identify some of the majority shareholder in such a case so they can be taken to court or everything settled bilaterally.
Why no tag-along?
While it is relatively easy to implement a drag-along clause in a smart contract, there is no straight-forward way to implement a tag-along clause. This illustrates that smart contracts are actually not that smart. A tag-along clause allows a shareholder to sell shares at the same price if other shareholders sell a large package of shares to a buyer. This is difficult to automatically enforce because a transfer of shares (which could easily be detected) does not necessarily imply a sale of shares and even if it does represent a sale, it is unclear what the price was. For example, if someone moves 1′000 shares from address 0x123.. to address 0x345.., it is not clear whether the 1′000 shares changed their owner. Maybe the holder just moved them to a more secure wallet or a different custodian? Furthermore, it would also be possible to sell the shares without moving them to a new address, for example when they are held by an intermediary and assigned to the new owner contractually. But even if we could reliably detect transfers of ownership, there is no guarantee that the according payment is visible on the blockchain and that there were no side-agreements between buyer and seller. Therefore, the enforcing of a tag-along term necessarily requires human intervention and cannot be automated. The same holds for a large number of other contractual clauses. We are fortunate that the most important one, the drag-along, can be represented with a relatively simple smart contract.
For this smart contract, we created a new type of software license, the “MIT License with Automated License Fee Payments”. Anyone is free to reuse the code as long as the built-in license fee, paid to Aktionariat AG, is preserved. The license fee is due whenever a new acquisition offer is made and is to be payed by the prospective buyer.