Venture Capital Term Sheet: Registration Rights

Eric A Koester

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Posted over 5 years ago. 13 helpful votes

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1

What are Registration Rights?

Registration rights are an important right to investors since they provide a contractual right for investors to demand that the company register their shares with the U.S. Securities and Exchange Commission. Following a registration, the investor can sell their shares on the public market. The importance of this right stems from the U.S. securities laws which permit the company, and not the shareholder, to register the company securities. In order to ensure that liquidity become an option for the investor, registration rights are negotiated as a part of the purchase.

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What are the typical types of registration rights?

Investors are typically granted certain registration rights from their transaction, consisting of demand rights (the right to require the company to register their shares with the SEC), "piggy-back" rights (the right to include their securities in the company's offerings registered with the SEC), and S-3 rights (the right to require the company to register their shares on the SEC's short-form registration statement; this applies only after the company has been public for one year and meets certain other tests).

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Demand Registrations

Registration on Form S-1 is an expensive and time-consuming process. Therefore, the demand registration rights can be a very burdensome obligation for the company. Usually the demand registration rights may not be exercised for three to seven years following the preferred stock purchase. If the company does make a registration on its own earlier than the three to five year minimum, there is generally a three to six month time period following the IPO until the investors can make their demand.

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Demand Registrations: Typical Provisions

From a company's perspective, the time limitations for the demand rights should be set at a reasonable time in the future to prevent the investors from requiring the company to go public before management and the company is convinced the company does represent an IPO candidate. In most cases, the shares that can be registered must (1) represent a specified percentage (perhaps as low as twenty percent and as high as two-thirds of the outstanding securities) or (2) their value must equal a minimum specified dollar amount (usually $5 million to $25 million). These limits are set to ensure that enough shares will be registered to make the effort and cost of the offering worthwhile. The company will usually limit the number of permitted demand registrations to a maximum of three.

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S-3 Registrations

A registration on Form S-3 is generally much less expensive and time consuming than registration on Form S-1 (since this filing can incorporate information from prior filings with the SEC). As a result, the company will often grant unlimited S-3 registrations upon request of holders of a minimum percentage of the shares that can be registered, oftentimes twenty to thirty percent. However, the S-3 registration right will usually be limited to one or two registrations in a single one year period. As with demand registrations on Form S-1, some companies will negotiate to limit the total number of S-3 registrations.

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Piggyback Rights

Piggyback rights permit the investor to participate in a public offering of securities by the company. These rights are not usually unlimited, providing the underwriters with the ability to limit the amount of shares that can be registered for sale if it will impact the public sale. These rights are generally fairly non controversial.

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Other Common Registration Rights Provisions

In addition to the registration and piggyback rights, the registration rights provisions oftentimes include information on responsibility of filing fees and transfer restrictions on registration rights. One key point on registration rights is to ensure that they terminate at some point after the company's IPO or when the investors can sell their shares under SEC Rule 144. Typical registration rights will provide the investor with two demand registrations that may be brought at any time commencing three to five years after the investment, along with piggy-back registration rights for Company offerings.

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