Can Shareholders Force a Private Company to Go Public?

When a startup begins operations, one of its primary needs is adequate financing. Startups commonly seek capital from venture capital funds, angel investors, private equity funds, strategic investors, and other private sources.

Under the Securities Act of 1933, every offer and sale of securities must either be registered with the Securities and Exchange Commission or qualify for an exemption from registration. Regulation D provides several exemptions that private companies frequently use to raise capital without conducting a registered public offering. (sec.gov)

Companies relying on Rule 504, Rule 506(b), or Rule 506(c) of Regulation D generally must file a Form D notice with the SEC within 15 calendar days after the first sale of securities in the offering. The company may also have notice-filing, consent-to-service, and fee obligations under applicable state securities laws. (sec.gov)

Important Regulation D Requirements

The applicable requirements depend on the exemption selected.

Offering limits: Rule 504 permits eligible companies to offer and sell up to $10 million of securities during a 12-month period. By contrast, Rule 506(b) and Rule 506(c) do not impose a maximum offering amount. (sec.gov)

Investor eligibility: Rule 506(b) permits sales to an unlimited number of accredited investors and up to 35 qualifying non-accredited investors within the applicable period. Rule 506(c) requires every purchaser to be an accredited investor.

General solicitation: Rule 506(b) generally prohibits general solicitation and advertising. Rule 506(c) permits general solicitation, but the company must take reasonable steps to verify that every purchaser is accredited. Rule 504 generally prohibits general solicitation, although limited exceptions apply. (sec.gov)

Restricted securities: Securities sold in most Regulation D offerings are restricted securities. Investors generally cannot resell them freely into the public market unless the resale is registered or qualifies for an exemption.

Rule 144 provides a nonexclusive safe harbor for certain resales. Restricted securities of a qualifying SEC reporting company generally must be held for at least six months. Restricted securities of a non-reporting private company generally must be held for at least one year. Additional conditions may apply depending on whether the seller is an affiliate of the company. (sec.gov)

Investors’ Registration Rights

The goals of a startup’s founders and investors may not always align. Founders may want to maintain control and pursue long-term growth, while investors may eventually want an opportunity to sell their shares.

Investors sometimes address this issue by negotiating a registration rights agreement. Registration rights are contractual rights; they are not automatically provided by the federal securities laws.

Demand Registration Rights

Demand rights allow qualifying investors to require the company to register specified shares for resale, subject to the agreement’s conditions and limitations.

A demand right does not necessarily allow an investor to force the company to conduct an IPO. Depending on the agreement and the company’s circumstances, it may instead require the company to file a resale registration statement for shares held by investors. Demand rights commonly specify:

• when the rights may first be exercised;
• the minimum number or value of shares required;
• the number of demands permitted;
• whether the company may postpone registration;
• who pays the registration expenses;
• whether the offering must be underwritten; and
• circumstances in which underwriters may reduce the number of shares included.

Piggyback Registration Rights

Piggyback rights allow investors to request that their shares be included in a registration initiated by the company or another eligible shareholder.

These rights are usually subject to exceptions and limitations. For example, the managing underwriters may be permitted to reduce the number of investor shares included in an offering if they determine that including all requested shares could adversely affect the offering. (sec.gov)

Protections Commonly Negotiated by the Company

A company may negotiate limitations that prevent registration rights from unduly interfering with its operations.

Postponement rights: The company may be allowed to postpone a demanded registration if proceeding would interfere with a material transaction, require premature disclosure of confidential information, or occur during seriously unfavorable market conditions.

Minimum offering thresholds: Demand rights may apply only if the proposed offering exceeds a stated dollar amount or involves a minimum percentage or number of registrable shares.

Waiting periods: Investors may be prohibited from exercising demand rights until a specified date or until the company has reached a particular stage of development.

Limits on frequency: The agreement may restrict how many demand registrations investors can require or impose a waiting period between registrations.

Underwriter selection: The agreement may give the company or its board the right to select the managing underwriters, sometimes subject to investor approval rights.

Underwriter cutbacks: The managing underwriters may have authority to limit the number of investor shares included in an offering.

Lockup obligations: Investors may be required to refrain from selling their shares for a specified period following an IPO or another underwritten offering.

Can Investors Ultimately Force an IPO?

The answer depends primarily on the company’s governing documents, financing agreements, and registration rights agreement. Share ownership alone ordinarily does not give an investor the unilateral right to force an IPO.

A carefully drafted demand registration right may require a company to pursue registration once the contractual conditions are satisfied. However, it may still leave important decisions—such as timing, offering structure, underwriter selection, and postponement—with the company or its board. Corporate-law duties, securities-law requirements, market conditions, and the precise contractual language will also affect the outcome.

Registration rights agreements are voluntary when negotiated, but they become legally binding once executed. Companies and investors should therefore define clearly when registration rights may be exercised, what exceptions apply, who controls the offering process, and how the related expenses will be allocated.

The securities lawyers at Corporate Securities Legal LLP assist founders, companies, and investors with private offerings, registration rights agreements, corporate governance, and preparations for registered offerings. Contact the firm to discuss how registration rights may affect your company or investment.