What are demand registration rights?
August 12, 2007
Demand registration rights entitle an investor to force a company to register shares of common stock so that the investor can sell them to the public. This effectively causes the company to undertake an IPO if the company is not yet public. Registrations are time-consuming and expensive, particularly if they involve underwritten public offerings of securities. These offerings require significant efforts from management, diverting them from the business of running the company. These offerings can even depress the market price of the company’s stock if the offering is poorly timed.
As a practical matter, I have never heard of a demand registration right being exercised by an investor. Completing an offering without company and management cooperation is impossible.
The items typically negotiated in the demand registration rights provision include:
- The number of demand registrations the investor can require. Because registrations are expensive, the company typically tries to limit it to one, while the investors typically want two.
- When the investor can make a demand. In an early state financing, a demand registration cannot be exercised until five years from the closing of the financing. In a later stage financing, the time period may be much shorter, depending on the expected potential IPO-readiness date. In addition, a demand registration right typically cannot be exercised for a certain time period after an IPO, such as 180 days.
- Who pays for the demand registration and up to what amount. Typically, the company pays for registration expenses and the expenses on a single counsel to the investors (which is subject to a cap).
- The minimum dollar size of a demand registration. Given the expense involved in a registration, companies want to set some minimum requirements on a demand registration so that it is a legitimate offering. The minimum price per share to exercise a demand registration and the minimum dollar amount of the offering are typically similar to the definition of a Qualified Public Offering that causes the preferred stock to convert to common stock. This is typically set at around 3x to 5x the purchase price of the preferred stock (5x in earlier stage financings and 3x or lower in later stage financings) and an aggregate of $20M or higher to be raised in the offering.
- Rights to delay a demand registration. Companies routinely request the right to delay a demand offering for a fixed maximum period of time if the company has commenced preparations for a public offering or believe a delay would beneficial because of market or other conditions or to avoid disclosing material company developments, such as pending merger negotiations.
- Whether the company needs to use “best” efforts or “commercially reasonable” efforts to effect a registration. Investors ask for “best” efforts, which may require registration irrespective of costs or effort disproportionate to benefit. However, some commentators suggest that there is no real difference between any of these standards.