Pre-emptive rights: Overview, definition, and example
What are pre-emptive rights?
Pre-emptive rights are the rights of existing shareholders to purchase new shares before a company offers them to external investors. These rights help shareholders maintain their ownership percentage when the company issues additional shares. Pre-emptive rights are usually included in a company’s governing documents or a shareholders’ agreement.
Why are pre-emptive rights important?
Pre-emptive rights help protect shareholders from dilution. Without them, a shareholder's stake in the company could shrink when new shares are issued, reducing their influence and the value of their investment. This protection is especially valuable in private companies, where maintaining control and negotiating power matters more. Including these rights supports fairness and transparency among shareholders.
Understanding pre-emptive rights through an example
Imagine a company with 1,000 shares, and a shareholder owns 100 (10%). If the company wants to issue 500 new shares, that shareholder could end up with only 6.7% of the company unless they’re given the chance to buy a portion of the new shares. With pre-emptive rights, the shareholder can buy up to 50 of the new shares (10% of the 500), preserving their 10% ownership.
Example of a pre-emptive rights clause
Here’s how a pre-emptive rights clause may appear in a contract:
"If the company proposes to issue any new shares, it must first offer such shares to the existing shareholders in proportion to their current shareholdings. Each shareholder shall have [15] days to accept the offer in writing. If any shares remain unsubscribed after this period, the company may offer them to third parties on terms no more favorable than those offered to existing shareholders."
Conclusion
Pre-emptive rights are a key protection tool for shareholders, especially in private companies. They help preserve ownership percentages, protect voting power, and prevent unwanted dilution. When reviewing a contract or investment agreement, businesses should check if these rights are included and clearly defined.
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.