Registration Rights

What are Registration Rights?

Registration rights are a form of control provision that enables investors to force companies to file a registration document, to serve purposes of both transparency and audit. The document must be filed with the Securities and Exchange Commission (SEC), complying with the Securities Act of 1933. According to this law, all securities need to be registered before a sale or any form of exchange.

Once a business registers securities, they become more liquid, which enables investors to sell the shares more easily. With the opportunity to sell the stock, the registration rights are considered a potential exit strategy, especially for those investors who hold a pessimistic view of how the stock price is going to change.

Types of Registration Rights

Registration rights can be classified into two main categories: demand rights and piggyback rights.

1. Demand Registration Rights

As the name implies, demand registration rights are rights that warrant investors to force the company’s hand into registering shares of common stock, thus allowing them to sell them to the public. This means that the business in question must become a publicly traded entity if it isn’t one already. Common attributes of such rights are:

S-3 Registration

Often, companies that are forced to register stock do so by registering on Form S-3. However, for a company to use Form S-3 for securities, instead of form S-1 that’s used for the original stock launch, it must meet the conditions below:

• Be a company that’s based in, and has its primary operations in, the U.S., a territory of the U.S., or the District of Columbia.
• Have a minimum of $75 million in public float. Public float is the term used to describe the portion of shares owned by public investors.
• Be a company that has traded a minimum amount of $1 billion in non-convertible shares (excluding common equity) for the past three years.
• Should not have defaulted making payments on dividends or sinking fund installments.

Number of Registration

Another attribute of demand registration rights is that there’s a limitation on the number of shares that preferred stockholders can demand.

Timing of Registration

The ideal time for registering rights usually occurs in relation to a major financing event, such as two years after the original investment of capital or 180 days after an initial public offering (IPO).

Value of Registration

The registration rights are restricted to certain periods when the value of the preferred shares is three to five times the buying price and a sum aggregate value of the issuance.

Expenses

Apart from forcing the company to register, investors can also transfer the costs of the registration to the company. The costs incurred during this process, such as legal fees, are incredibly high. Thus, being able to avoid the expense is beneficial to the investors.

Lock-up Period

Investors concur that the stock that gets registered as part of the IPO cannot be exchanged or traded for a period that is stipulated in the regulatory requirements. Usually, the period is for 180 days after the underwriting process.

Best-Efforts Requirement

Shareholders can also add a clause requiring the company to put in their best efforts when conducting the registration process.

2. Piggyback Registration Rights

Piggyback registration rights are rights that entitle investors to register their unregistered stock at the time when the company is carrying out an IPO or when it has initiated the registration process.

Piggyback rights are considered inferior to demand rights because shareholders need to wait for the company to initiate the registration. Other attributes of piggyback rights include:

Share Reduction

IPO underwriters have a right to minimize the capability of investors to take part in the offering. In some instances, the underwriters can cut out the investors completely. If that happens, then the investors have the advantage in subsequent offerings. Thus, they can negotiate that they are allowed to participate up to a certain percentage.

Priority

Piggyback rights also allow investors to be given priority over stockholders of non-company shares. This means that they’ll be able to participate in the registration process while others are excluded.

Summary

There are two primary categories of registration rights: demand and piggyback rights. With demand registration rights, investors have a right to force a company to register shares with the SEC. Once registered, the shareholders can then sell their shares to outside investors and exit the company.

Conversely, piggyback rights allow investors to register any unregistered shares they own, but only when the company or another stockholder initiates the process. In such a case, the investors do not have as much power as those with demand registration rights.

Related Readings

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional CFI resources will be very helpful:

• Glass-Steagall Act
• Initial Public Offering (IPO)
• Stockholders Equity
• Underwriting
• See all economics resources