What's The Deal With Registration Rights? 5 Things To Consider At Initial Investment

SMART SUMMARY

• Registration rights are contractual rights that facilitate share resales by sponsors and other pre-IPO shareholders once a company goes public
• These rights are often negotiated at initial investment, even when a public exit is unlikely or not in the near future, and include demand, shelf and piggyback rights

When investing in a private company or taking a public company private, you may see “Registration Rights” included as a line item in a term sheet or as a section in the governing agreement. Below we describe the what, why, who, how and one more what of registration rights. Registration rights tend to be highly technical and use a lot of jargon, but the bottom line is: well-negotiated registration rights provide you with the best flexibility and optionality to exit your investment through the public markets in an orderly fashion. While we generally discuss exits through IPOs below, registration rights also apply when companies go public via a direct listing or de-SPAC transaction.

1. What are registration rights?

A company's debut in the public markets with a stock exchange bell-ringing, while a significant milestone, does not result in all pre-IPO shares being “public,” or freely tradeable. Under the Securities Act of 1933, any issuance of shares by the company or resale of shares by pre-IPO shareholders must be made pursuant to an effective registration statement or pursuant to an exemption from registration. Securities issued to sponsors pre-IPO are typically issued under an exemption to this requirement, in a private placement. As such, sponsors acquire “restricted securities,” meaning they cannot be reoffered or resold to the public without either registration under the Securities Act or pursuant to another exemption. “Registration Rights” are contractual rights between a company and certain shareholders to obligate the company to file a registration statement and take other actions to facilitate the reoffer and resale of securities by such shareholders under the Securities Act.

2. Why do you need registration rights?

Absent a contractual obligation to do so, a company is not under any legal obligation to register the reoffer or resale of shares for its shareholders. Due to legal and market considerations, liquidating a substantial position can take years for large pre-IPO investors. Sponsors negotiate registration rights to enhance their liquidity options in the event of a public exit, and in some cases, to compel an IPO. Registration rights clearly define the rights and procedures related to registered resales by shareholders, including through underwritten offerings. Registration rights also delineate rights and obligations of pre-IPO shareholders (e.g., lock-up requirements and provisions for notice or coordination of sales).

3. Who gets registration rights?

Typically, all pre-IPO shareholders receive registration rights in pre-IPO governing documents. In addition to sponsors, this includes founders, directors and management that own pre-IPO securities. However, the relative rights and obligations of such pre-IPO holders will vary depending on deal dynamics and impact negotiated terms.

4. How are shares registered?

Registration rights generally comprise three main rights: demand, piggyback and shelf registration rights. Demand rights allow shareholders to compel a company to facilitate registered offerings of shareholder securities by filing the requisite registration statement and undertaking other related actions. Piggyback rights provide shareholders the right to join in, or “piggyback” onto, registrations proposed by the company or other selling shareholders. Shelf registration rights allow shareholders to require the company to file a specific type of registration statement, called a shelf registration statement, which can be used from time to time for resales, including open market sales, underwritten offerings and block trades. Shelf rights also often include rights to compel an underwritten takedown. Generally, demand rights and underwritten takedowns are the most burdensome for the company and, as such, are subject to the most limits. For example, there may be a cap on the number and frequency of demands or underwritten takedown requests as well as requirements that an offering will have certain minimum expected proceeds. 

5. What should you think about when negotiating registration rights?

The leverage you have in negotiating registration rights provisions frequently depends on your position in the cap table as well as whether you will be deemed an affiliate of the company. Registration rights provisions in pre-IPO governing documents require that similar provisions be included in any new registration rights agreements entered into postIPO. The level of detail and negotiation of such provisions at the outset can impact your post-IPO rights, which means what you negotiate at investment can be applicable for a lengthy period of time if there is a public exit. Conversely, if an IPO exit is unlikely or you want to negotiate these rights at the time of an anticipated IPO, you may not want to spend a lot of time negotiating at the time of your investment and save your negotiating leverage for other deal terms. Deal dynamics and timing will often dictate the approach to registration rights at initial investment.

Key considerations at this stage, which your Weil deal team will be focused on and help you navigate, include:

• How long will you have registration rights? Registration rights may have a set term or may fall away when other exemptions for resales are more readily available or your ownership percentage dips below a certain threshold. If you expect to be an affiliate of the company post-IPO (which is a fact-specific inquiry), you will likely have registration rights for a longer period of time than non-affiliates given the nuances of the securities laws.
• What are your demand or underwritten takedown rights? The ability to make demands or request underwritten takedowns and the related limitations will often depend on such things as the timing of investment, ownership percentage and rights vis-à-vis other sponsors (if any).
• What are the limitations on piggyback rights? While common to carve out certain offerings and registration statements from piggyback rights, participation in the IPO or underwritten block trades for certain holders may be limited due to market and timing considerations.
• What are the parameters to initiating an IPO? Some registration rights provisions dictate which sponsors may be able to initiate an IPO. These rights may only kick in after a certain period of time and be subject to various parameters (e.g., require a certain estimated equity value of the company at IPO).
• When are lock-ups required and are there shareholder coordination provisions? In order to provide an orderly market, lock-up provisions obligate other registration rights holders to agree not to sell their shares for a period of time following offerings or block trades and certain shareholders may be required to coordinate with, or notify, other holders in connection with sales and distributions (even if not registered) for a specified period post-IPO.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.