Registrationright

Understanding Registration Rights and Their Impact on Investors

Key Takeaways

Registration rights allow investors to compel a company to list restricted shares publicly for sale, potentially turning private companies public.
Demand rights permit investors to force a company to initiate an IPO, which can be contentious due to costs and market conditions.
Piggyback rights let investors include their shares in a company’s planned registration without forcing an IPO.
Registration rights are negotiated in share purchase agreements to prevent untimely IPOs and include terms like lock-up periods and registration costs.
Investors and companies should balance registration rights to avoid unnecessary IPOs, ensuring stability before potentially going public.

What Are Registration Rights?

Registration rights are contractual agreements that allow investors who own restricted stock in a company to demand that the company registers these shares for public sale. This process can effectively transform a privately held company into a publicly traded one, offering liquidity opportunities for investors. Registration rights, including demand and piggyback rights, ensure that investors can access broader market opportunities when they want to sell their shares.

We'll explain the different types of registration rights, their impact on private companies, and how they affect shareholder agreements and investors.

How Registration Rights Benefit Investors and Companies

Registration rights are usually assigned when a private company issues shares in order to raise money. In practice, registration rights held by a group of minority investors seldom come into play. The majority block of shareholders typically decides if or when the company goes public.

Registration rights can help investors holding private shares gain access to the broader market to sell their shares. Early investors may have shorter time horizons than company founders for a liquidity event and thus may wish to exercise these registration rights.

However, exercised rights can potentially have significant impacts on a company. A private company would have to go through the initial public offering (IPO) filing process, which is often expensive, perhaps premature for the principals of the firm and its shareholders, or too dilutive. Employees would have to dedicate time to organizing material required for the SEC Form S-1 filing instead of focusing on day-to-day business operations.1 The IPO might also wind up reaching the market at an inopportune time (suboptimal market conditions), which could lead to the share price being lower than desired.

Rights are typically negotiated when privately-held shares are purchased. Typical negotiation points include the number of rights allotted to the investor, with management likely preferring fewer rights due to IPO expenses. The company may prevent registration rights from being enacted for several years, especially if the company is in the early stages of raising funds. This prevents the company from being pushed to go public before it has operated long enough to be stable.

Important

It is in the company’s interest to limit the effect of registration rights.

Exploring Piggyback and Demand Registration Rights

Registration rights take the form of either "piggyback" or "demand." Piggyback rights allow investors to have their shares included in a registration that is currently in the planning stages by the company. Piggyback rights generally do not cause issues for a firm.

Demand rights are the type of registration rights described in the preceding sections, and these can be contentious for the reasons discussed. Unless there are clear and compelling reasons to initiate an IPO process, founders and principal stakeholders will rebuff the exercise of demand rights.

Key Clauses in Registration Rights Agreements

Registration rights typically contain clauses that establish the terms of registration. Among these details is the "lock-up" period during which investors are prohibited from selling their shares in a company after it has gone public. Typically, this is limited to 180 days.

Expiration of the lock-up period often results in the selloff of a company's stock and a fall in its price. For example, the shares of social media company Snap Inc., fell by as much as 5% after expiration of its lock-up period. Other clauses included are the termination of registration rights for investors and establishing responsibility for registration payment to the company's management.

U.S. Securities and Exchange Commission. "Registration Statement." Accessed Apr. 5, 2021.

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