What registration rights do investors receive in venture capital financings?
Takeaway: Investors typically receive (i) demand registration rights (called S-1 registration rights) permitting the investors to require the company to register shares usually before or in connection with its IPO, (ii) follow-on registration rights (called S-3 registration rights) permitting investors to require the company to register shares after the IPO, and (iii) piggyback registration rights permitting investors to require the company include their shares in any registration the company does on its own.
In the world of venture capital financing, registration rights play a role in protecting the interests of investors. These rights are often negotiated as part of the terms of a funding round and grant investors the ability to sell their shares in a public offering more easily. In this post, we will explore what registration rights are, the different types of registration rights typically offered to investors, and their importance in venture capital financings.
What are Registration Rights?
At a baseline, in order to sell shares of stock, federal securities laws require companies to either register the shares with the Securities and Exchange Commission (SEC) or rely on an exemption from the SEC’s registration requirements. Registration rights are contractual rights that provide investors with the ability to require a company to register their shares with the SEC so that they can be sold by the investors to the general public. Registration rights help investors to more easily sell their shares in the public market, though, in practice, they are very infrequently used in a startup context.
Types of Registration Rights
There are two primary types of registration rights that investors typically receive in venture capital financings:
Demand Registration Rights: Demand registration rights give investors the ability to require a company to file a registration statement with the SEC for the sale of their shares. Typically, the group of investors requesting registration must hold a certain percentage of the company's outstanding shares of preferred stock to exercise this right. There are usually limits on the number of times an investor can demand registration (often no more than 1-2 per year), and companies may have the right to delay or "cut back" on the shares included in the registration under certain circumstances.
Piggyback Registration Rights: Piggyback registration rights allow investors to include their shares in a registration separately initiated by the company for its own shares or those of other stockholders. This means that when the company files a registration statement with the SEC, investors holding piggyback registration rights can request to have their shares included in the offering, allowing them to sell their shares alongside the company or other stockholders. Companies also typically have the right to limit both the number of piggyback registrations (usually not more than 2 per year) and the number of shares included in a piggyback registration if the underwriters believe it would negatively impact the offering.
The Importance of Registration Rights in Venture Capital Financings
Investors in venture capital financings negotiate for registration rights primarily because by providing investors with the ability to more easily sell their shares in a public offering, registration rights can help improve liquidity, allowing investors to exit their investment and potentially realize a return.
Conclusion
Despite rarely being used in a startup context, registration rights play a role in ensuring that investors have the ability to sell their shares in a public offering. By understanding the different types of registration rights and their importance, both investors and startups can better navigate the complex world of venture capital financing and build a strong foundation for a successful partnership.