An investor rights agreement (IRA) is a vital document for any startup that raises venture capital and should be drafted with care and attention to detail. The IRA sets out the rights and obligations of the company and the investors and covers various topics, such as registration rights, information rights, preemptive rights, and other covenants. Start-up entrepreneurs should understand the implications of each provision and negotiate them with investors in a way that balances their needs and goals. Below, we highlight some key provisions of the IRA.
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Registration rights allow investors to sell their shares in a public offering.
There are two types of registration rights: demand and piggyback. Demand rights give the investors the power to require the company to file a registration statement, while piggyback rights give the investors the right to join a registration statement initiated by the company. The IRA typically provides for limited demand registrations on Form S-1 and Form S-3 and unlimited piggyback registrations. However, demand registrations on Form S-1 are rarely exercised, as the IPO process is costly, time-consuming, and dependent on market conditions. Registration rights are often subject to cutback, lockup, and transfer restrictions limiting which shares can participate and when.
Information rights give investors the right to receive financial and corporate information.
The IRA usually requires the company to provide annual, quarterly, and sometimes monthly financial statements, periodic capitalization tables, a right to inspect the company's books and records, an annual budget and business plan, and other material information upon request. The information rights are typically limited to “major investors,” defined in the IRA, and not available to competitors. The right to appoint a board observer who can attend board meetings and receive board materials in a non-voting capacity may also be granted. These rights help the investors monitor the company's performance and governance and terminate upon an initial public offering (IPO) or a sale or liquidation of the company.
Preemptive rights give the investors the right to participate in future equity financings.
Preemptive rights, or a right of first offer (ROFO), allow investors to avoid dilution and maintain their stake in the company. The ROFO is usually available to “major investors” and applies to any subsequent equity financing of the company but is frequently waived by the investors to avoid complications in a financing. As with information rights, the ROFO terminates upon an IPO or a sale or liquidation of the company.
The IRA also contains other covenants that the company agrees to comply with, such as maintaining directors’ and officers’ insurance and key person insurance, obtaining specified preferred director approval for certain actions that affect the investors' interests, ensuring that employees and contractors sign confidentiality and invention assignment agreements, and memorializing investors’ right to conduct other investment activities. These covenants are designed to protect the investors' rights and interests and to promote the company's growth and success.