Rights to future stock issuances: Overview, definition, and example
What are rights to future stock issuances?
Rights to future stock issuances are contractual provisions or agreements that give an individual or entity the right, but not the obligation, to purchase additional shares of a company's stock in future stock offerings or issuances, often at a pre-determined price. These rights are typically granted to existing shareholders, investors, or other stakeholders, and they help protect their ownership percentage by allowing them to buy shares before the company offers them to new investors.
These rights are commonly found in private equity or venture capital deals and are also known as "preemptive rights" or "subscription rights." By exercising these rights, holders can maintain their proportional ownership in the company and avoid dilution of their shares as new stock is issued.
Why are rights to future stock issuances important?
Rights to future stock issuances are important because they allow existing shareholders or investors to protect their ownership stake in a company. Without these rights, a company could issue additional shares to new investors, potentially diluting the value and control of existing shareholders. This can be particularly critical in early-stage companies or closely held businesses where maintaining control is important.
For businesses, offering rights to future stock issuances can make their stock offerings more attractive to investors, providing a sense of security that they will have the opportunity to purchase additional shares if necessary. For investors, these rights are an important tool for safeguarding their investment and preventing dilution from future stock issuances.
Understanding rights to future stock issuances through an example
Imagine a startup, ABC Tech, which has raised initial funding from several investors. As part of the investment agreement, the investors are granted the right to purchase additional shares in future funding rounds. This is known as the right to future stock issuances.
Several months later, ABC Tech decides to issue more shares to raise additional capital for expansion. The investors who initially funded the company are given the right to purchase new shares before the company offers them to new investors, ensuring that their percentage of ownership remains unchanged. The investors choose to exercise their rights and purchase the additional shares at a favorable price, maintaining their control and stake in the company.
In another example, a publicly traded company may grant rights to future stock issuances to its existing shareholders when planning a new offering of shares. Shareholders are notified that they have the opportunity to purchase additional stock in proportion to their current holdings, often at a discount or at the market price. This gives shareholders the chance to avoid dilution if they choose to participate in the new stock issuance.
An example of a rights to future stock issuances clause
Here’s how a rights to future stock issuances clause might look in an investment agreement:
“The Company hereby grants the Investor the right to purchase additional shares of the Company’s stock in any future issuance, at the same price per share as offered to other investors, in order to maintain their proportional ownership in the Company. The Investor’s right to purchase additional shares will be exercisable for a period of [insert time period] following the Company’s notice of the new stock issuance.”
Conclusion
Rights to future stock issuances are an important tool for both companies and investors. For companies, they provide a way to raise capital while maintaining the confidence of existing shareholders. For investors, these rights offer a way to protect their ownership percentage and avoid the dilution of their investment. Whether in private or public companies, these rights are a critical element in equity financing agreements and shareholder protections.
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.