IPO Participation Rights

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​Definition​ An IPO participation rights (or initial public offering shares purchase) provision in a term sheet specifies a minimum percentage of shares that the investor may have the option to purchase in the event of an IPO. Some term sheets state that the investor must have this option if the company IPOs, while others simply require the company to do everything in its power to provide the option.*

​danger​ Investors may like to see an IPO participation rights clause in a term sheet because it signals the company is headed toward an IPO,* but this clause can cause trouble with the SEC if the participation rights are granted too close in time to the IPO. Before a public offering, a company’s shares are not registered with the SEC and Section 5 of the Securities Act of 1933, as amended, prohibits selling or offering to sell unregistered securities unless an exemption applies. To stay on the right side of the SEC, founders and investors may consider including language that grants IPO participation rights only “if permissible under the securities laws.”*

​important​ If a term sheet is going to include an IPO participation rights provision, founders should generally prefer the “best efforts” provision that stops short of mandating that the investors must have the option to purchase the specified percentage of shares. This is because a company works with other entities, such as investment banks, when preparing an IPO, and the company does not have complete control over how shares will be distributed.*