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It is common for shareholders in a company to have pre-emptive rights. Pre-emptive rights affect how a company can issue and transfer shares. Likewise, they affect whether or not shareholders get a right of first refusal. Accordingly, they aim to protect shareholders from third parties purchasing shares and diluting their ownership percentage interest. This article will outline what pre-emptive rights are, if your company has them, and the advantages of having pre-emptive rights.

What Are Pre-emptive Rights?

Pre-emptive rights allow shareholders to have the right to apply for their proportionate share of new or existing shares before third parties. Essentially, when one shareholder is looking to sell their shares, other shareholders with pre-emptive rights will have the opportunity to purchase or refuse those shares. This is known as the right of first refusal. 

Likewise, these rights enable your company to allocate a certain number of shares to a shareholder, reflecting their ownership proportion. Your company might offer shares when issuing new shares or transferring existing shares. Through these rights, your shareholders can avoid dilution of their investment. 

Suppose your shareholders do not have pre-emptive rights. In that case, when issuing or transferring shares, your company can offer those shares to the general public without first offering them to existing shareholders. As a result, the shareholdings of existing shareholders will be diluted.

Importantly, if pre-emptive rights exist, it is essential to note that all shareholders have an equal right to buy the shares. This prevents one shareholder from purchasing all the shares and unfairly increasing their shareholding in the company. 

Additionally, it is an excellent option to have pre-emptive rights so your shareholders can increase their ownership interest while preventing unknown third parties from entering the business and becoming shareholders. 

Does Your Company Have Pre-emptive Rights?

While it is common for pre-emptive rights to apply, you should check your company’s shareholders agreement and constitution

If your company does not have a shareholders agreement or constitution, or those documents are silent on pre-emptive rights, then the Companies Act applies.

The Companies Act provides that shareholders have pre-emptive rights over the issue of new shares. However, it does not cover pre-emptive rights over the transfer of shares. Therefore, if your company does not have a shareholders agreement or constitution that provides that pre-emptive rights apply on a transfer of shares, shares will be able to be freely transferred by shareholders, including to unrelated third parties. 

The rights under the Companies Act will apply unless and until the shareholders agreement or company constitution overrides them. 

Process Involving Pre-emptive Rights

If your company has pre-emptive rights, there is usually a process that directors and shareholders must follow when issuing or transferring shares. Typically, the first step is for the company directors or selling shareholders to prepare a notice that sets out the:

  • terms of issue or sale;
  • number of shares on offer; and
  • price per share.

Additionally, you must circulate the notice to all existing shareholders, setting out each specific shareholder’s entitlement. Those shareholders will then have a specific timeframe to accept (or decline) the offer to buy the shares. Also, there is a timeframe on whether they wish to take up their full entitlement. 

In writing, the shareholder will need to tell the board of directors how many shares they want to subscribe or buy. 

Often shareholders can apply for more than their entitlement if, for example, some shareholders choose not to take up their entitlement. If the number of shares taken up is more than the amount on offer, each shareholder will be allocated shares at their respective proportion. If shares remain, your company should either re-offer them to existing shareholders or offer them to third parties. 

Notably, following the entire pre-emptive rights process in full can be time-consuming. Hence, shareholders may, instead, simply choose to waive their rights. This will often happen to allow the company to seek funding from external investors. Provided all shareholders sign the waiver of rights, the company will be free to issue new shares to investors.

Advantage of Pre-emptive Rights

Having pre-emptive rights can be advantageous to both your company and its shareholders. 

Advantages to your company include:

  • the ability to save money because the company does not have to go to an investment bank to offer new shares to the public;
  • it is cheaper to sell to existing shareholders and;
  • the opportunity to increase profitability and business value by saving costs.

Further, there are advantages for the shareholders, including:

  • shareholders being protected from losing their voting rights power as the company issues more shares and;
  • shareholders may receive a special deal and price for shares, which is a strong profit incentive.

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Key Takeaways

Pre-emptive rights protect your shareholders from dilution as the company will only issue shares to one other shareholder. To understand if your company has pre-emptive rights, you should check your shareholders agreement and company constitution. If no such documents exist, then the Companies Act applies. 

There are specific processes to be followed when exercising pre-emptive rights. If you need more help in understanding if your company has pre-emptive rights, contact our experienced business lawyers who can assist as part of our LegalVision membership. You will have unlimited access to lawyers who can answer your questions and draft and review your documents for a low monthly fee. Call us today at  0800 005 570 or visit our membership page

Frequently Asked Questions

How do I know if my company’s shareholders have pre-emptive rights?

You can check your company’s shareholders agreements or the company constitution to see if pre-emptive rights apply to shareholders. If neither of your governing documents mentions pre-emptive rights, then the Companies Act will apply.

What are pre-emptive rights?

Pre-emptive rights give shareholders the ability to purchase a proportionate number of shares on any issue of new shares in the company, or transfer existing shares in the company. Exercising these rights allows a shareholder to protect their proportionate interest in the company from dilution. In addition, shareholders can subscribe for or purchase shares before the company offers them to third parties.

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