Many investors focus on exit possibilities from an investment, especially when the investment is in the form of a privately issued security (as opposed to a publicly traded security). Negotiating registration rights into the set of rights granted to security-holders is one way that investors structure exit options into preferred stock investments. While commonly included in preferred stock, it's important to understand the set of rights granted to investors via this provision. A Priori start up and securities attorney can help you understand registration rights from both a company and investor perspective.
Understanding Registration Rights
Registration rights (or "reg rights") are rights granted to investors that give investors the power to compel a company to register shares of common stock (into which preferred stock is convertible) with the Securities Exchange Commission (SEC) under certain specified circumstances. Investors in private companies, especially minority investors without the voting power to force another exit-facilitating event, often request registration rights as a way of increasing the likelihood of a successful exit from the investment. Without such registration rights, the disposition of such privately purchased preferred shares can be difficult to acheive.
Before an IPO
Technically, if a company is private, exercising registration rights before an IPO forces the company to go public. For practical reasons -- not least the cost and effort involved in an IPO -- this rarely happens without the cooperation of management. However, this leverage allows holders of shares with registration rights ensure that an IPO or other profitable exit is possible.
After an IPO
Just because a company has an IPO doesn’t mean that all shares immediately become publicly traded. Those held by initial investors that were not included in the first issuance remain private and must be registered separately. Registration rights exercised after an IPO can force a business to register a new class of shares with the SEC.
Piggyback Vs. Demand Registration Rights
The most common form of registration rights -- called full registration rights or demand registration rights -- permit the securityholder to force the company to register a sale of securities with the SEC. Piggyback registration rights, on the other hand, are more limited. Rather than permitting a shareholder to force a registration of securities with the SEC, piggyback registration rights allow a shareholder to include covered shares in any registration initiated by the company or another shareholder.
Registration Rights Agreement
Registration rights are conferred and governed by a registration rights agreement. Generally, a registration rights agreement includes information like procedures and timing for the registration process, indemnifications, and contribution provisions similar to those contained in an underwriting agreement. The company and all investors holding registration rights are parties to the agreement. Often, the registration rights agreement is negotiated simulataneously with the initial investment.
Can investors with registration rights exercise these rights whenever they want?
No. In general, registration rights cannot be exercised for the first several years following the purchase of securities. The length of the waiting period varies, but generally there is a fairly long period of time following the investment during which the investor cannot exercise registration rights -- especially if the company is fairly early stage (for early stage companies, this prohibition on exercising registration rights serves to prevent the company from being pushed into registerting its securities prematurely. Even once this period has passed, most registration rights can be deferred for a period of time (often up to twelve months) in the event that registering a class of securities with the SEC could negatively impact material negotiations carried out by the company, such as by revealing a merger or acquisition being in process.