Last Updated on December 18, 2022 by Anda Malescu
As used in a company shareholders’ or operating agreements in the United States, the preemptive right is important to shareholders because it protects current shareholders against dilution of their ownership interest in the company.
Preemptive rights also known as preemption rights, anti-dilution provision or subscription rights, offer shareholders the right to purchase a proportionate number of shares in any future issue of the company’s stock in order to maintain his or her percentage ownership in the company. Simply put, preemptive rights give shareholders the right to buy a certain number of shares anytime the company issues more shares to avoid decreasing their ownership interest in the company. The preemptive right belongs to an existing shareholder; only an existing owner has the right to purchase newly issued shares before the shares are offered and sold to new investors.
The use of the preemptive right is important to shareholders because it provides them with an opportunity to buy new stock and keep their percentage ownership in the company without being obligated to do so. In other words, the right does not require shareholders to purchase additional shares if they choose not to do so. In cases where shareholders choose not to exercise their preemptive rights the shares are sold to new investors and the existing shareholders proportion of ownership declines.
An example may help you understand how preemptive rights work and why are they important to shareholders
Let us say that The Coffee Company, Inc. has 1,000 shares outstanding and you own 100 shares of the Company (this means you own 10% shares of the Company). Now, the board of directors of The Coffee Company, Inc. wants to raise capital to expand the business and open a new store in Miami, Florida. To achieve its expansion plans, the board decides to issue and sell an additional 1,000 shares in the company for the price of $5 per share.
Following the new issuance, the Company has 2,000 shares outstanding. If the preemptive right does not exist, the new issuance of stock will dilute your percentage ownership to 5%. This is because you still own 100 shares but now the Company has 2,000 shares issued and therefore your ownership is sliced in half (100 shares divided by 2,000 shares outstanding).
However, if an agreement provides for a preemptive right, then you can exercise your right to maintain your initial 10% interest in the company and agree to purchase or subscribe to 100 shares of the new stock. All you have to do is pay $500 for the new stock (100 shares at $5 per share) to the company and you own the same 10% percent of the entire Company (200 shares out of 2,000 shares outstanding).
Practically, the preemptive right ensures that the shareholders ownership interest does not get diluted even if the company issues more shares. The preemptive rights provision is usually found in the shareholders’ agreement but can also be included in other agreements such as a merger agreement or an operating agreement.
In conclusion the preemptive right is important to shareholders because it allows existing shareholders of a company to avoid involuntary dissolution of their ownership by giving them an opportunity to buy a proportional interest in any future issuance of stock.
Taking steps to protect your rights as a shareholder is important. Contact us or schedule a consultation with your business attorney in Miami, Florida USA, to protect your rights and your financial interests.
Malescu Law P.A. – Business Lawyers
