Welcome back to our Anatomy of a Term Sheet series. We are taking the model Series A term sheet from the NVCA, and analyzing the various terms in depth.
Last time we began a discussion of registration rights, and focused on demand registration rights. Today we are going to focus on two other kinds of registration rights — piggyback rights and S-3 registration rights — as well as expenses and lockup terms.
Piggyback Registration Rights
Here is the piggyback registration rights term from our Model Term Sheet:
The holders of Registrable Securities will be entitled to “piggyback” registration rights on all registration statements of the Company, subject to the right, however, of the Company and its underwriters to reduce the number of shares proposed to be registered to a minimum of [20–30]% on a pro rata basis and to complete reduction on an IPO at the underwriter’s discretion. In all events, the shares to be registered by holders of Registrable Securities will be reduced only after all other stockholders’ shares are reduced.
This is a fairly straightforward and noncontroversial term. Basically, if the company is going to be registering its securities with the SEC for a public offering, the investors want to be able to register the securities they hold at the same time. This will enable the investors to cash out without complying with Rule 144’s requirements.
There are a couple of interesting aspects to note. In the case of an IPO, the underwriter has the discretion to override the piggyback rights of the investor. In the case of subsequent public offerings, the underwriter can cut back the percentage of the investors’ shares that will be permitted to piggyback on the registration.
Founders and management should also negotiate to have piggyback registration rights, for the same reason the investors want them. The founders will want to participate in an IPO or other public offering, so they can cash out shares without complying with the requirements of Rule 144.
S-3 Registration Rights
The S-3 registration rights term is as follows:
The holders of [10-30]% of the Registrable Securities will have the right to require the Company to register on Form S-3, if available for use by the Company, Registrable Securities for an aggregate offering price of at least $[1-5 million]. There will be no limit on the aggregate number of such Form S-3 registrations, provided that there are no more than [two] per year.
A Form S-3 registration is shorter and less burdensome than the Form S-1 registration used in an IPO. It can be used by the company one year after an IPO, and allows the company to reference certain items contained in other SEC filings. Consequently, while the S-3 registration rights are demand rights, they aren’t as burdensome as the primary demand registration rights.
The company will want to limit the number of S-3 registrations to 1 or 2 a year, because of the costs and time involved. The company also will want to set a minimum dollar amount for S-3 registrations (somewhere between $1 million and $5 million), again because of the cost and time involved.
Expenses and IPO Lockup
There are two other items related to registration rights worth covering while we are on the subject. The first is expenses. Typically the company will pay the expenses of an SEC registration. Our model term sheet also contains a provision for the company to pay for one special counsel to represent all participating stockholders, subject to a negotiable cap on fees.
The second item is the IPO lockup. The lockup term prevents investors, directors, officers, and major shareholders (1-5%) of the company from selling their shares until 180 days after an IPO, if the underwriter requests. This allows the market to adjust and absorb the additional sales.
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