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Registration, Piggy-back & Demand Rights

Typically, there are only three exit strategies through which a private startup company can provide liquidity and generate capital gains for the investors: (1) a public offering (IPO); (2) sale of the startup to, or merger with, a public company; and (3) redemption or repurchase of the startup's shares by the startup itself or by it major shareholders. If a startup has a substantial fixed assets, a re-capitalization, by which debt is incurred in order to provide the investors and founders with a partial return on their investment by repurchase of their shares, may be effected.

Registration covenants are important where a public offering is the most likely exit strategy, since the investors will usually hold restricted securities issued in a private offering which will have to be registered if sold publicly. Since the amount of restricted securities held by the investor group will usually be too large to sell under exemptions of section 72, registration rights will require the company to file a registration statement covering the resale of large blocks of shares held by the investors, usually at the startup's expense. Such rights are broken down into two major types: (1) piggyback rights; and (2) demand rights.

Piggyback rights provide that the startup will register restricted securities held by the investors only when the startup elects to effect a registration of its own securities. Thus, the startup controls the timing of registering restricted securities for the investors. Usually such registration is not overly onerous, since the startup would already be undertaking the registration for its own offering at the startup's expense.

Demand rights provide that if no piggyback registration has occurred during a specified period of time, the startup will be required to file a registration statement covering the restricted securities of the investors upon their demand. Often there is a time limitation, for example, that no demand registration can be required by the investors before the lapse of a three to five year period of time, to allow the startup to elect a public offering and consequent registration at its own initiative and timing. Usually a demand right is limited to one or two registrations and only after a year or two has elapsed after the startup's initial public offering.