Exit strategy is perhaps the most important item on any
private equity investor's checklist. Many investors,
particularly in new economy investments, look to a US listing
(often on Nasdaq) for this exit.
But simply getting the initial listing of the target company
in the US is only half the battle. The investor must also be
able to register its shares for sale to the public after the
initial public offering (IPO), and this registration cannot
occur without the cooperation of the company. Rights to force
the company to cooperate in the registration process –
commonly known as registration rights – are integral
to an investor's exit strategy in the US public markets. These
rights are also called demand registration rights, to
distinguish them from piggyback registration rights described
To understand the importance of registration rights to
investors in a US public company, a bit of background on US
securities laws is necessary. The United States is one of the
few jurisdictions in the world where shares must be registered
(or where an exemption from registration must be available)
before the shares are sold to the public. The shares are
registered under a registration statement, which includes a
prospectus, which is filed with the US Securities and Exchange
Commission. The company prepares, and must stand behind, the
registration statement, and accordingly it is impossible to
register shares without the cooperation of the company.
Investors should also note that shares cannot be registered and
held; only shares to be sold can be registered.
Registration rights are not provided by statute. They can
only be granted in a registration rights agreement between the
company or the controlling shareholders, on the one hand, and
the investors to be granted these rights on the other. (These
agreements may also be called investor rights agreements or
similar names. The relevant provisions from the registration
rights agreement may also be part of a larger shareholders'
Registration rights agreements should address at least the
- Who will be granted the rights?
- When may the rights be exercised?
- How often may the rights be exercised?
- When may the company refuse to honour the rights?
- Will piggyback rights be granted?
- When are cutbacks appropriate?
- Who pays for the registration?
- Should the company indemnify the shareholders, and vice
- When do registration rights terminate?
This article will discuss each of these questions, with a
view to providing practical guidance to investors in
negotiating these agreements.
Who will be granted these rights?
This is the most basic question facing investors and the
company, and in some respects the most difficult. There is no
standard or correct approach to determine what investors will
get registration rights.
As a practical matter, controlling shareholders seldom need
registration rights, because they can force a company to
register their shares at any time because of their influence
over the board of directors.
The question becomes more difficult when deciding whether
some or all outside investors should be granted registration
rights. If registration rights are granted, it is not unusual
for them to be granted to all minority outside (i.e.
non-management) investors. It is also not unknown for
distinctions to be drawn among groups of minority investors in
terms of who is granted registration rights. Later-round
investors, who may be paying much more for their shares than
earlier-round investors, may argue that their greater
investment justifies that they alone should be granted
registration rights, or that at least their rights should be
superior in certain ways, such as a right to take precedence in
registering their shares in any oversubscribed offering.
At the same time, if earlier-round investors have veto
rights over the issuance of additional equity, they may use the
threat of vetoing the later round of financing as leverage to
get registration rights equivalent to those of later-round
Two factors often drive who will or will not be granted
registration rights: the price the investor pays for its
shares, and the amount it is purchasing. The greater the price
for the shares, and the greater the amount purchased, the more
likely the investor will be granted registration rights.
A related issue is whether the registration rights are
personal to the investor to whom they have been granted (and,
if so, whether the registration rights may be transferred to
any subsequent purchaser of these shares), or whether they run
with the shares (meaning that any holder of the class or series
of shares to which registration rights have been granted has
the benefit of these rights). If personal registration rights
are transferable to subsequent purchasers, the company will
sometimes require that the purchaser acquire a minimum amount
of shares before the registration rights may actually be
When may the rights be exercised?
Investors usually demand, and companies often agree, that
registration rights become effective immediately following the
expiration of any lock-up (typically six months) following the
initial public offering of the company's shares in the US.
Investors and the company often spend more time debating
whether the registration rights can be used to force a company
to go public in the US, even before management and the
controlling shareholders think it is ready. If the registration
rights become effective on a certain date (regardless of
whether the IPO has taken place), they can be used to take the
company public starting on this date.
Companies typically resist granting investors these rights
to take them public. US public companies are subject to a host
of regulatory burdens and constraints that will significantly
affect the operation of the company. Moreover, bringing a
company to market before it is ready may harm its reputation or
its ability to raise financing in the future. Controlling
shareholders may be concerned about putting such a decision in
the hands of minority investors, whose interests may be focused
more on short-term financial gain and less on long-term growth
and management of the company.
Nonetheless, companies do from time to time grant such
rights, particularly where the investors have great economic
leverage, or where necessary to quell investor concerns about
future exit opportunities. If such a right is granted, however,
it is not unusual for the effective date to be a number of
years after the investment, to give management and the
controlling shareholder an opportunity to bring the company to
the public markets at the time and under the circumstances they
On a related issue, the company will often require that a
certain minimum threshold of registrable securities be
registered in connection with any single registration request,
so that the company is not required to go through the time and
expense of a registration (which can be considerable) unless a
substantial number of shares are involved. This threshold is
often expressed in terms of a percentage of all outstanding
registrable securities or an aggregate dollar amount based on
the market price of the registrable securities at the time the
request is delivered. Large investors will often request that
this number be set so as to allow them (in light of the size of
their holdings) to deliver one or more registration requests
without needing the participation of other investors.
How often may the rights be exercised?
Registration rights agreements often contain two types of
limits on the number of times registration rights may be
exercised. The first type caps the number of requests that any
one investor or group of investors may make during the life of
the registration rights agreement. The second type caps the
number of times a request may be made during any given period
of time, for example that no more than one registration request
may be delivered to the company during any nine-month
There are no standard numbers, but it is fair to say that
these caps, particularly of the first type, are often set in
relation to both the number of registrable securities (and the
percentage of the company's total share capital they represent)
and the expected liquidity of the market for the company's
shares. A good rule of thumb is that the greater the number of
registrable securities, or the more illiquid the market, the
higher the cap, under the theory that it is beneficial both for
the company and the investor if a relatively large block of
shares may be dribbled out over time (particularly in an
illiquid market), rather than dumped all at once.
When may the company refuse to honour the
Many registration rights agreements allow the company to
decline to honour a registration request if the disclosure of a
pending corporate transaction in connection with the
registration would negatively impact the company. For example,
if the company is in secret negotiations to sell a major
business, these negotiations might potentially need to be
disclosed in the registration statement. This disclosure might
scupper the deal. In these circumstances, the company could
decline to honour the registration request.
At the same time, registration rights agreements often limit
the number of times during a given period (for example, once in
any 12-month period) that a company can rely on such a
provision, so that a company cannot perpetually point to
pending transactions as an excuse not to honour registration
What are piggyback rights?
In addition to, or instead of, demand registration rights,
registration rights agreements often provide piggyback
registration rights, that is the right to include shares in (or
piggyback on) a registration initiated by the company or
another shareholder. The piggybacking selling shareholder is
not in the driver's seat in the registration process, but is
essentially along for the ride initiated and controlled by the
company or another shareholder.
Piggybacking on a registration is possible because there is
no limit on the number of shares, or on the number of sellers
of shares, that may be included in any one registration
statement. Since the marginal cost to the company of including
additional sellers under one registration statement may be
relatively small, companies are quite often willing to grant
them. Piggyback registration rights, however, are inferior to
demand registration rights, in at least two respects.
First, the holders of piggyback rights have no ability to
initiate a registration process. They may only participate in
one initiated by the company or by another shareholder.
Accordingly, having piggyback registration rights alone may not
be appropriate for an investor that needs to control the timing
of its sale into the market.
Second, shares to be sold under piggyback registration
rights are typically excluded from an offering in favour of
shares sold under demand registration rights if the
underwriters determine that the market cannot absorb all of the
shares to be registered.
On the positive side, registration rights agreements often
allow the holder of piggyback registration rights to
participate in an unlimited number of registrations (subject to
the cutbacks described below), but not subject to any of the
caps described above.
When are cutbacks appropriate?
Most registration rights agreements provide that the shares
to be registered will be sold to the public in a firmly
underwritten offering. Accordingly, there may be situations
where the underwriter will advise that the market cannot absorb
all of the shares requested to be registered at the prices
sought. For these situations, registration rights agreements
typically provide for some mechanism to cutback the number of
shares that the investors and the company may register.
There is no standard way in which these cutbacks are
allocated, but a few principles typically apply:
- if the company wishes to participate in a registration,
the holders exercising demand registration rights will often
either be fully cutback before the company is cutback at all
(under the theory that the company should have unimpeded
access to the markets when it needs it), or the cutbacks will
be made on some type of pro-rata basis between the company
and the holders exercising demand registration rights;
- investors exercising demand registration rights (as
opposed to piggyback rights) are typically cutback among
themselves in some pro-rata manner (assuming they have
otherwise identical demand registration rights); and
- investors exercising piggyback rights are typically fully
cutback before either the company or the investors exercising
demand registration rights are cutback.
Who pays for the registration?
The company may often pay for the incidental expenses of
registration, including filing fees, printer's fees, company
accountant's fees and similar expenses (even if the company is
not itself registering any shares for sale to the public).
Whether the company will pick up fees for counsel to the
investors is less certain. Even if the counsel fees are paid
for by the company, limits may be placed on the number of
counsel whose fees will be reimbursed (for example, one counsel
to all investors), or on the amount of counsel fees that will
be reimbursed for any one registration.
Selling shareholders will, almost universally, pay the
underwriting commissions and discounts associated with selling
Should the company indemnify the shareholders, and
Under US securities laws, the company has strict liability
for any material mis-statements or omissions in a registration
statement. Selling shareholders also have some liability for
mis-statements or omissions. Accordingly, selling shareholders
typically request that the registration rights agreement
contain an indemnification from the company to each selling
shareholder for any liability arising from such material
mis-statements or omissions, other than with respect to
information provided by the shareholder in writing for
inclusion in the registration statement.
In turn, the company often asks for a similar indemnity from
each selling shareholder for any liability of the company
arising from material mis-statements or omissions in any
information provided in writing by the shareholder for
inclusion in the registration statement. In this respect,
investors should note that any shareholder selling shares under
a registration statement will have to provide some basic
information about itself, including its name and number of
shares held. An anonymous sale is not possible.
When do registration rights
It is not unusual for registration rights agreements never
to terminate. So long as the investors have not made all of the
demand registrations to which they are entitled, and so long as
there are other registrations on which they may piggyback,
their rights may survive.
At the same time, some registration rights agreements do
provide for termination, at least of demand registration
rights, if all of the registrable securities held by an
investor may be sold (either all at once or during a short
period of time) under Rule 144 of the US Securities Act. Rule
144, sometimes called the dribble-out rule, generally allows a
holder of unregistered shares to dribble out these shares to
the public market after the investor has held them for at least
a year, but there may be limits on the amount of shares that
can be dribbled out during a given period of time, as well as
restrictions on how these shares may be sold to the public.
It is not common to see registration rights agreements
terminate simply after a period of time following the initial
public offering in the US.
Many issues arising under registration rights agreements are
the subject of negotiation, taking into account the investment
climate at the time and the economic leverage of the investors.
An experienced US lawyer can be helpful to an investor
attempting to navigate these issues and maximize the value of
this important exit strategy.
Debevoise & Plimpton
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39 Queen's Road
Tel: 852 2160 9800
Fax: 852 2810 9828