The shareholders of a company have many rights and responsibilities. Shareholders’ pre-emptive rights affect the process by which a company can issue shares, or how shareholders can sell their shares. Hence, it is important to understand what they are and how they can impact you.
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What are Pre-emtive Rights?
Pre-emptive rights allow shareholders to subscribe for new shares or purchase existing shares before they are offered to third parties. They also allow for the shareholder to purchase shares that another shareholder sells before they offer them to third parties such as the general public. If shareholders choose to use their pre-emptive rights, they are allocated the number of shares that reflects their proportionate ownership in the company. Pre-emptive rights are a contractual clause usually found in the shareholder’s agreement. Shareholders who have pre-emptive rights are usually early investors to the startup. They can also be majority owners who want to maintain the size of their stake in the company.
The Process
When a company’s shareholders have pre-emptive rights, there are rules that must be followed when issuing or selling shares. You should check your company’s constitution and shareholders agreement to determine whether shareholders have pre-emptive rights. First, the directors or selling shareholders must prepare a notice setting out the terms of the issue or the sale. The notice must include the number of shares on offer and the price per share. This notice is then shared to all existing shareholders.
The existing shareholders have a set timeframe in which they can partake in the notice offered. Each shareholder wishing to subscribe or purchase shares, will need to write to the board declaring the number of shares they would like. If the total number of shares wanted is greater than the total number of shares on offer, each shareholder will be allocated shares at their respective proportion. If the total number of shares taken is less than the total on offer, the company will offer or re-offer any remaining shares to a third party.
Benefit to Shareholders
Pre-emptive rights have various benefits for the shareholder. These include, protecting the shareholder from losing voting power as the company issues more shares. Additionally, the shareholder is receiving a special deal and price for the new shares. Hence there is a strong profit incentive. The pre-emptive rights also give the shareholder the choice of converting preferred stock to additional shares if the new share price lowers.
Benefit to Companies
Pre-emptive rights for shareholders also benefit the company. It is cheaper for a company to sell shares to current shareholders than offering to sell shares to the general public, as the company would not need to pay for investment banking services. This saving would have a direct effect on the company’s profitability and business value. The savings would lower the company’s cost of equity, and hence its cost of capital, which in turn would increase the business’s value.
In conclusion, pre-emptive rights are very important to a shareholder. If you have any other questions, ask a business lawyer today.
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