A registration rights agreement (RRA) typically accompanies an equity-linked transaction and spells out the registration obligations of the issuer. Typically, these obligations are designed to ensure that the shares underlying the equity-linked instrument(s) are freely tradable. In many cases, the only means for the investor to receive return of invested capital and a return on that capital is to convert the instrument into the underlying shares and sell.
In the absence of registration, the shares are not freely tradable until the Rule 144 holding period has elapsed. Since registration is critical to the investor’s investment, the RRA will often set forth very stringent registration obligations and may have monetary penalties in the event that the company fails to meet the requirements. An RRA may provide for the initial registration of the shares as well as maintaining the effectiveness of the registration through timely filings of reports with the SEC. The RRA may also provide for the listing of the shares on a recognized exchange, maintaining that listing or both.
An RRA can have two primary accounting impacts. First, there is the penalty for failure to meet the registration and/or listing obligation(s). The FASB refers to this as a ‘registration payment arrangement’ and has provided specific accounting guidance in the form of ASC 825-20 which addresses payment arrangements involving registration of the shares with the SEC as well as payment arrangements involving listing of the shares on an exchange. ASC 825-20-15-3 provides unusually clear (for the FASB) description of the arrangements that fall within the scope of ASC 825-20. ASC 825-20-15-4 lists the instruments/transactions that are specifically excluded from its scope. The most significant of these exclusions, in my opinion, is the last which covers a payment arrangement that actually settles the related instrument. This is not a penalty. It is a settlement alternative that is contingent on a future event and must be addressed in the context of the related instrument which is usually a warrant or a convertible instrument, but could be any other equity-linked instrument covered by the RRA. Settlement alternatives for equity-linked transactions have potentially far-reaching effects. If the payment arrangement settles the instrument, include this in the analysis of the instrument using our equity-linked transaction analysis tool.
But, assuming is within the scope of ASC 825-20, you simply account for the payment arrangement as a contingency in accordance with ASC 450-20. In other words, disclose the contingency if material, but give no other accounting recognition until the obligation becomes probable and reasonably estimable and/or the contingency is resolved (i.e., you have incurred a liability as a result of failing to meet the terms of the RRA). I’ll leave the full treatment of contingency accounting to another post.
The second primary accounting impact of an RRA is its role in evaluating the related equity-linked instrument (warrant, convertible note, whatever…) under the various applicable accounting guidance. For example, the RRA may impact the determination of whether or not the company can settle the instrument in registered shares. This could impact the determination of whether the instrument (or embedded feature within the instrument) is subject to derivative accounting or other fair value accounting.
The real point to this second impact, is that the accounting issue is not actually the RRA itself, but its effect on the analysis of the related equity-linked instruments. The settlement alternative issue mentioned previously is but one of these. We designed our equity-linked transaction analysis tool to address these areas.