What is a Registration Rights Agreement?

In the United States, shares must be registered with the SEC before they can be sold to the public. In turn, it is impossible to register shares without the company preparing a registration statement and, along with a prospectus, filing said statement with the Securities Exchange Commission. The right to register one's shares is not granted by federal or state statute, but rather, by mutual agreement between a company and investors. This article will address the key provisions that must be included in a Registration Rights Agreement.

The agreement should first address which investor or investors will receive the right to register their shares. Controlling shareholders rarely require registration rights since they can force a company to register their shares at any time. Sometimes registration rights are granted to all outside, minority investors at the same time. Other times distinctions may be drawn among groups of minority investors. If distinctions are drawn, which groups receive rights is usually determined by the price the investor pays for its shares and the number of shares it purchased. The higher the purchase price the greater the chance to receive the right to register. Likewise, the more shares one owns, the greater the chance.

The agreement should also address when the registration rights will become effective. Registration rights usually become effective immediately following the expiration of any freeze on selling a company's stock, which is usually six months following the IPO of the company's shares in the United States. 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 shares.

The agreement should address when the company may refuse to honor the rights. Many registration rights agreements allow the company to decline to honor 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.

Finally, the issue of indemnification should be addressed in the agreement. Under U.S. securities laws, the company has strict liability for any material misstatements or omissions in a registration statement. Selling shareholders also have some liability for misstatements 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 misstatements or omissions, other than with respect to information provided by the shareholder in writing for inclusion in the registration statement.
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. Investors should utilize the services of an experiences securities lawyer to draft or review the agreement and ensure their rights are being protected.