No preemptive rights: Overview, definition, and example
What are no preemptive rights?
No preemptive rights refer to a provision in a company’s governing documents or contracts that prevents existing owners or shareholders from automatically having the right to buy new shares or ownership units before they are offered to outside investors. This means that when a company issues additional equity, existing owners do not have a guaranteed opportunity to maintain their proportional ownership.
For example, if a startup raises capital by issuing new shares, existing shareholders with no preemptive rights would not have the first option to purchase those shares before new investors.
Why are no preemptive rights important?
No preemptive rights allow businesses to issue new shares or units freely without being obligated to first offer them to existing owners. This can help companies raise capital more efficiently, attract new investors, and maintain flexibility in their equity structure.
For investors, the absence of preemptive rights means their ownership percentage could be diluted when new shares are issued. However, companies may choose to include protective provisions, such as requiring majority approval for new issuances, to balance fairness with flexibility.
Understanding no preemptive rights through an example
Imagine an LLC with three members, each owning one-third of the company. The LLC decides to issue 1,000 new units to an outside investor. If the company’s operating agreement includes a “no preemptive rights” clause, the existing members are not entitled to purchase any of these new units, meaning their ownership percentages will be diluted.
In another example, a corporation raises additional capital by selling new shares to the public. Shareholders without preemptive rights do not get a guaranteed opportunity to buy these shares before new investors, potentially reducing their percentage of ownership in the company.
Example of a no preemptive rights clause
Here’s how a no preemptive rights clause might appear in a contract:
“No Member shall have any preemptive, preferential, or other rights to acquire any Units of the Company that may be issued at any time.”
Conclusion
A no preemptive rights clause ensures that businesses can issue new shares or units without first offering them to existing owners. While this provides flexibility for raising capital and bringing in new investors, it may also result in ownership dilution. Companies and investors should carefully consider the implications of preemptive rights when structuring agreements.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.