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Registration Rights Definition
Registration rights are control provisions that allow an investor to force the business to file a registration statement with the Securities and Exchange Commission (SEC) and state regulators. The Securities Act of 1933 regulates the transfer or sale of securities. Specifically, it requires that securities be registered prior to sale or exchange. The registration process can be costly and burdensome. As such, startups rely heavily on exemptions for the securities registration requirements. Many of these exemptions restrict the sale of securities to certain third parties, thereby reducing the liquidity of the securities. Specifically, Rule 144 restricts the sale or exchange of certain securities for one year following their issuance. Forcing registration of shares makes the shares liquid and allows investors to easily sell the shares and exit the venture.
Registration rights are often defined to s specific class of shares (generally common stock). And these rights are generally grouped into “piggyback” and “demand” registration rights.
Demand & Piggyback Registration Rights
Demand rights provide the investor with the ability to force the business to register a class of shares with the SEC. Demand rights are often contingent on the occurrence or non-occurrence of certain events or conditions, such as a certain period of time. Piggyback rights allow an investor or class of investors to be a part of any registration of the business’s securities. That is, if another class of security holder registers a class of security, the investor with registration rights can also participate in that registration.
Demand registration rights will generally have any of the following attributes:
- S-3 Registration – Holders of a certain class and percentage of securities may require registration via form S-3. Registration is generally completed on form S-1. S-3 is less burdensome, as it allows for the reference of disclosures made in other filings. The S-3 may only be used 1 year following an IPO. The number of shares and dollar value of a S-3 registration will be limited.
- Number of Registrations – The articles may restrict the number of registrations a holder of preferred shares may demand. This may not be an issue as preferred shares have conversion rights to common shares, which is generally the target of registration demands.
- Timing of Registration – The time period is generally linked to a major funding event, such as 3 years after the original investor or 180 days following an IPO of the common shares.
- Value of Registration – Registration rights are generally limited to periods when the price of the preferred shares is 3-5x the purchase price of the preferred shares and a total aggregate value of the issuance (e.g., $10 million).
- Expenses – Shareholder may allocate the cost of registration (or any portion thereof) to the company. The costs associated with registration (i.e., legal fees) can be incredibly expensive. The cause of the expense is the extensive due diligence involved with making the mandatory disclosures. Failure to make accurate disclosures can lead to extensive civil and potentially criminal liability. In some cases, the expenses born by the company will be capped at a certain dollar value based upon the size of the registration.
- Lock-up Period – Shareholders agree that shares registered as part of an IPO will not be traded or exchanged for a period sufficient to comply withe regulatory requirements (180 days following the completion of the underwriting process). This reduces the likelihood of challenges to insider trading or market manipulation claims.
- Termination of Registration Rights – Generally upon an event where the corporation is liquidated, shares become unrestricted, or on a date related to an IPO.
- “Best-Efforts Requirement” – The investors may include a clause requiring the best efforts of the company in effectively carrying out the registration.
Piggy-back Registration Rights will generally have any of the following attributes:
- Share Reduction – Underwriters in an IPO may generally cut back the ability of investors to participate in the offering. As such, piggyback registration rights will generally allow investors to limit the ability of underwriters to cut back their participation in any follow-on issuances. The rights may assure the shareholders the ability to participate up to a given % in any subsequent financings.
- Priority – The investors may negotiate for their shares to have priority in any registration of shares above any other holders of non-company shares. This would allow those shareholders to participate in the registration while others cannot.
- Eligible Participants – The parties will negotiate whether common shareholders have the ability to participate in the registration. Otherwise, they are limited in their ability to liquidate their holdings.
Allowing investors to control the decision to make a public offering of the business shares protects the investor when the entrepreneur has majority control and complete decision-making authority over the business. The shareholder can either sell her shares in any public offering or force a public offering as a method of exiting the venture. While piggyback registration rights mitigate the investor’s perceived risk, demand rights shift control to the investor and risk to the entrepreneur. Specifically, an investor may demand registration to pursue an exit that does not benefit the entrepreneur or the business. This particular situation is known as “grandstanding”, when the investor seeks an exit to promote personal interests rather than those of the business. In practice, parties negotiate to limit the ability of the investor to unilaterally initiate a public offering. As such, registration rights are more of a tool that offers the investor leverage or control in the relationship.
References for Registration Rights
Academic Research on Demand Registration Rights
· Securing land and property rights in sub-Saharan Africa: the role of local institutions, Toulmin, C. (2009). Land use policy, 26(1), 10-19. This paper asserts that local institutions and governments are more effective at implementing and maintaining a land distribution system when compared to large, central governments. The reasoning for this belief is explained, taking into account the demographics and geography of sub-Saharan Africa.
· The demand for land title registration: theory with evidence from Kenya, Miceli, T. J., Sirmans, C. F., & Kieyah, J. (2001). American Law and Economics Review, 3(2), 275-287. By examining the process of land registration in Kenya, the authors show that title registration helps strengthen property rights for landowners. A simple model shows how these landowners manage the issue of security versus cost, and how the demand for registration helps to improve the value of land in general.
· Indigenous land rights in Sub-Saharan Africa: Appropriation, security and investment demand, Sjaastad, E., & Bromley, D. W. (1997). World Development, 25(4), 549-562. This article argues that African farmers are motivated by productivity and the gain or property rights when it comes to deciding how to use and invest in land. The article looks at the connections between investment, land rights appropriation, and tenure security in sub-Saharan Africa. A conceptual model shows that indigenous tenure may provide the best results in this situation and might be useful in other areas around the world.
· Institutional Investors, Registration Rights, and the Specter of Liability Under Section 11 of the Securities Act of 1933, O’Hare, J. (1996). Wis. L. Rev., 217. This article outlines the rights of investors as they can become potential defendants in lawsuits targeting the issuers of securities. The author finds this to be a new and dangerous interpretation of the Securities Act of 1933 as they lay out the process and implications of this practice.
· The effect of registration of title upon customary land rights in Kenya, Coldham, S. (1978). Journal of African Law, 22(2), 91-111. This paper examines the environment of land rights among the Kikuyu people in Kenya during the mid-1950s. This paper looks at the contrast between the attitudes and practice of modern land consolidation schemes versus those of traditional land-practices and institutions.
· The benefits of land registration and titling: economic and social perspectives, Feder, G., & Nishio, A. (1998). Land use policy, 15(1), 25-43. This paper shows that there is worldwide evidence of the benefits of land registration. Even with all these benefits, there are social conditions which are required for a land-registration system to viable. The authors also find some emerging issues which they feel require more study.
· Changing property rights: Reconciling formal and informal rights to land in Africa, Ensminger, J. (1997). This paper addresses how modernizing attitudes toward land rights in Africa are sometimes at odds with traditional practices toward owning and working land. While some standard economic theories offer an explanation, the author also recognizes unique systems of social and traditional organization that require a modification of official policy. A compromise between formal and traditional systems is recommended.
· Formalisation of land rights in the South: An overview, Sjaastad, E., & Cousins, B. (2009). Land use policy, 26(1), 1-9. This paper addresses the notion that formal property rights can reduce poverty. The authors suggest that historical evidence shows that this method has mixed results. They offer an approach that they think is flexible and more in tune with local politics and cultures.
· Indigenous land rights systems in sub-Saharan Africa: a constraint on productivity?, Migot-Adholla, S., Hazell, P., Blarel, B., & Place, F. (1991). The World Bank Economic Review, 5(1), 155-175. This article challenges the notion that traditional land rights in sub-Saharan Africa reduce the overall productivity of the areas in question. Using cross-sectional data from Ghana, Kenya, and Rwanda, the authors find that commercialization and population growth have helped individual rights grow out of traditional systems of communal control.
· An introduction to registration rights, Ostrognai, A. (2001). International Financial Law Review, 44. This paper offers an overview of registration rights as they exist in the U.S. The author offers a definition of these rights, as well as a history and a discussion of their importance in the securities and financial markets.