Investors that own restricted shares of a privately-held company need access to a broader market to eventually sell those shares. Such investors need to have the right or ability to require the company to list the shares publicly. This would most commonly occur through an initial public offering (IPO). Shareholders can force an IPO through registration rights agreements.

Registration rights refer to this right of investors holding private, restricted shares. They can compel the company to list its shares publicly. When an investor exercises a registration right, the investor can compel a privately-held company to go public.

Investors often enter into registration rights agreements in the startup context. At some point, startups issue shares in order to raise money during a financing round. Common startup investors, such as venture capital firms and angel investors, often receive restricted stock in the company. This restricted stock starts out privately held. Registration rights come into play once the company switches from being privately-held to becoming a public company. Investors holding restricted securities are then able to exercise their registration rights. They may sell their shares once the company goes public and the lock-up period has expired.

Lock-Up Period

Early investors in a company may desire to sell their shares shortly after an IPO or other liquidity event. A significant number of investors may want to utilize their registration rights agreements to sell their shares at once. However, this could have a potentially dilutive impact on the company. It also would cause a sudden dip in the stock price. The dip would take place shortly following the IPO if a bunch of investors sold their shares at the same time.

A lock-up period seeks to protect against this problem. The lock-up period most commonly extends 180 days from the IPO date. During that period, investors holding pre-IPO shares may not sell their shares. This helps reduce stock price volatility in the days and weeks after the IPO or other liquidity event. Hence, registration rights agreements.

A massive selloff can occur if a large percentage of pre-IPO investors decide to liquidate their shares immediately after the 180-day lock-up expires. For example, the stock price of Snap Inc. saw its stock price fall around 5% after the expiration of its lock-up period.

Registration Statement Filed with the SEC

Under federal securities law, a registration statement if a prerequisite to securities offerings. The company files this statement with the Securities and Exchange Commission (SEC). The registration statement discloses information about the company, its business model, the management structure, and the planned security offering. It also includes any registration rights agreements.

Demand versus Piggyback Rights in Registration Rights Agreements

There are two types of registration rights agreements: for demand registration rights and for piggyback registration rights. Investors with demand rights can force a company to an IPO so that the investors can liquidate their shares. After the investors exercise the demand rights, the company must register shares of common stock and other securities for a public offering. This registration process, which involves the SEC, is costly and time-consuming.

To protect the company from an IPO at an early stage of its existence, the company typically restricts early investors from exercising their registration rights agreements. This is for a certain period of time after a given financing round closes. Investors in early stage financing rounds of the company often may not exercise demand rights until five years after the financing round closes. For investors participating in later stage financing rounds, a shorter time period applies.

Piggyback rights allow an investor to sell their shares following an IPO by “piggybacking” on other investors’ demand registration rights. In other words, investors with only piggyback rights will have to rely on investors with demand rights to exercise those demand rights.

Holders of Piggyback Rights Can’t Control Timing

Investors with only piggyback rights, unlike investors with demand rights, are thus not able to control the timing of an IPO or other liquidity event. These investors are also generally treated as lower priority than investors with demand rights. The consequence of being lower priority is that, in a situation where not all of the shares can be sold through an IPO, the investors with piggyback rights may not actually be able to exert those rights.

From the company’s point of view, both demand and piggyback registration rights are mechanisms to reward early investors in the company. Allowing early investors an opportunity to liquidate their shares after the IPO can pave the way for share purchases by new investors on the public market. Such new investors might have a greater interest in the long-term growth prospects of the company.

Registration Rights Agreements as Key Document

The Registration Rights Agreement (RRA) is the key document that governs the terms and conditions of the restricted securities held by early investors in a company and their rights following the IPO. The most heavily negotiated terms in the RRA include the timing of the demand registration rights, the extent of the company’s right to delay a demand registration, and the minimum dollar amount of the securities offering required when a demand right is exercised.