Registration Rights

What are registration rights?

Registration rights are, under US law, contractual claims of investors against the company to have their shares registered for public resale. The competent authority is the US securities regulator, the SEC (Securities and Exchange Commission). Only registration permits sale on the public market. Registration rights belong to US capital markets law and have no direct equivalent in German law.

In US funding rounds, registration rights are set out in the Investors' Rights Agreement, together with information rights and pre-emptive rights. German companies encounter them when US investors bring their model documents into a term sheet or when a listing in the USA is planned. For an IPO in Germany, the underlying questions are resolved differently: through the prospectus and admission, lock-up periods and the secondary placement of existing shares.

Registration rights under US law

Under US securities law, public offerings and sales of securities must be registered with the SEC unless an exemption applies. Shares from private funding rounds are therefore restricted in their tradability. After an IPO they can be sold without registration only under exemption provisions that provide for holding periods and, for insiders, volume limits. Registration rights oblige the company to carry out a registration at the investors' request and to bear its costs.

The three basic forms

• Demand registration: Investors with a minimum holding can require the company to initiate a registration. The number of such demands is limited. The right can usually be exercised only some years after the funding round or some months after the IPO, whichever is earlier.
• Piggyback registration: the right to include one's own shares in a registration that the company is carrying out anyway, for example for a capital increase. The accompanying banks may reduce the quantity offered by existing shareholders (cutback).
• Short-form registration: If the company, after some time as a listed company, meets the requirements of the simplified Form S-3, investors can demand a quick registration for ongoing sales.

The basic forms are supplemented by ancillary rules. The company may postpone a registration for a limited time, and after the IPO a holding period (lock-up) applies during which the investors may not sell. The company indemnifies the investors against liability for incorrect statements in the registration documents, unless the statements originate from the investors themselves. The rights lapse as soon as investors can sell freely without registration.

Transfer to German and European practice

Admission and prospectus instead of registration

German and European law does not provide for registering individual blocks of shares for resale. A prerequisite for exchange trading in the case of a GmbH (German limited liability company) is first a change of legal form under the German Transformation Act (Umwandlungsgesetz), usually into a stock corporation (Aktiengesellschaft, AG), less often into a partnership limited by shares (Kommanditgesellschaft auf Aktien, KGaA). A European company (Societas Europaea, SE) generally arises only in a further step from the stock corporation. Admission to the regulated market generally requires a securities prospectus under the EU Prospectus Regulation. This is an information document on the company and the shares, which in Germany is approved by the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin). The application for admission must in principle relate to all shares of the same class. With admission, the shares of existing shareholders therefore also become tradable, without the need for a separate claim.

Secondary placement and holding periods

The counterpart to the piggyback registration is the secondary placement of existing shares. In an IPO, the underwriting banks, that is, the banks accompanying the issue, offer not only new shares from a capital increase (primary tranche) but also shares of existing shareholders (secondary tranche). The size of the secondary tranche depends on demand and is agreed with the banks. How it is allocated among existing shareholders willing to sell should be agreed beforehand. After the IPO, lock-up agreements with the banks bind existing shareholders and management, often for six to twelve months. Thereafter, the rules against insider trading and market manipulation in particular restrict sales.

Rules in the shareholders' agreement

German shareholders' agreements therefore regulate the IPO through obligations of the shareholders to cooperate in the IPO. The interests behind the three basic US forms are reflected there as follows:

• Instead of demand registration: the right of a qualified majority to resolve on an IPO as an exit route, combined with the obligation of all shareholders to support the change of legal form and amendments to the articles of association. This does not create a claim to a successful placement.
• Instead of piggyback registration: a rule on how a secondary tranche is allocated among existing shareholders willing to sell. This includes who bears the costs. Often each seller bears the bank commission for its own shares.
• Instead of short-form registration: no separate rule, because all shares are tradable upon admission. Larger blocks are often sold by investors after the lock-up period through banks in an accelerated placement with institutional investors (accelerated bookbuilding).

In addition there are the removal of preferential rights such as the liquidation preference in favour of uniform ordinary shares without preferences and the obligation to accept customary lock-up periods.

Worked example: allocation of the secondary tranche in an IPO

After the change of legal form, a company has 40 million shares. In the IPO, 6 million new shares and 4 million existing shares are offered at EUR 20 per share. Three investors want to sell: A 6 million, B 3 million and C 1 million shares. Under the shareholders' agreement, the secondary tranche is allocated in proportion to the sale requests.

• Demand of existing shareholders: 6 + 3 + 1 = 10 million shares for 4 million available places, allocation ratio 4 / 10 = 40%.
• Allocation: A 6 million × 40% = 2.4 million, B 3 million × 40% = 1.2 million, C 1 million × 40% = 0.4 million shares.
• Proceeds: A 2.4 million × EUR 20 = EUR 48 million, B EUR 24 million, C EUR 8 million, together EUR 80 million.
• Primary tranche: 6 million × EUR 20 = EUR 120 million gross proceeds for the company.
• Free float after the IPO: 10 million placed shares out of 46 million shares in total, so about 21.7%.

The investors' unsold shares are subject to the lock-up period. Without a distribution rule agreed in advance, the investors would have to negotiate the split under the time pressure of the issue.

Distinction: registration rights, IPO and secondary sale

• IPO: the stock exchange listing itself. Registration rights concern the resale of investor shares in connection with the IPO and afterwards.
• Direct listing: the listing without an offering of new shares. Here too, existing shares in Europe are admitted on the basis of a prospectus.
• Secondary sale: the sale of existing shares outside the stock exchange to a single acquirer. In Germany it requires neither registration nor a prospectus.
• Co-sale agreement: the US agreement on rights of first refusal and co-sale rights in private share sales. Registration rights begin only at the public market.

Common mistakes

• US clause adopted unchanged. An obligation to register with the SEC is pointless for a German company without a US listing and creates unclear obligations.
• No allocation rule for the secondary tranche. Without one, the allocation is only decided during the issue.
• Preferential rights not adapted. If it remains open how liquidation preferences end at the IPO, this delays the change of legal form and the prospectus.
• Costs unregulated. Without a rule, it is open who bears the costs of a secondary placement for existing shareholders.

Frequently asked questions

Do registration rights apply to a German GmbH?

No, not in their US form. They become relevant only if the company, after a change of legal form or through a holding company, wants to offer shares publicly in the USA or have them listed there.

What is a registration rights agreement?

A US agreement in which the company undertakes to have the investors' securities registered with the SEC. In funding rounds based on US models, these obligations are usually set out in the Investors' Rights Agreement. As a separate agreement, the registration rights agreement occurs mainly in private placements with institutional investors, for example under the US exemption Rule 144A.

What corresponds to registration rights in German law?

There is no direct equivalent. Admission to the regulated market in principle covers all shares of the same class. The investors' interests are secured by cooperation and allocation rules in the shareholders' agreement for the IPO.

Can investors force an IPO?

Practically not. An IPO requires shareholder resolutions, the cooperation of the management, banks and receptive markets. Contractual cooperation obligations can prepare an IPO but cannot enforce it against market conditions.

May existing shareholders sell immediately after the IPO?

Legally the shares are tradable upon admission. Sales are, however, restricted by the agreed lock-up periods, often six to twelve months, and by the rules against insider trading.

The Roemer Capital view

Roemer Capital encounters registration rights mainly in term sheets of international investors. It explains to the client that these rights do not fit a German GmbH and names the interests behind them: the ability to sell in an IPO, the allocation of costs and lock-up periods. How they are implemented in the shareholders' agreement is decided by the company's law firm.

Roemer Capital's focus is on funding rounds from Series A to C and on company sales. In both, it makes sure that provisions for an IPO do not make a sale to a strategic acquirer more difficult.