Preemptive rights are a clause granting a shareholder the right to buy stock issued by the company in the future before they become publicly available.
What are preemtive rights?
Preemptive rights are a clause granting a shareholder the right to buy stock issued by the company in the future before they become publicly available. These rights are usually given to early investors or majority shareholders. They are sometimes also referred to as “anti-dilution-provision”.
Benefits of preemptive rights
One big benefit for shareholders is the chance to maintain the original percentage of stock and voting power in the company whenever it offers a new round of common stock.
Another advantage of preemptive rights comes into play when the next round of common stock is offered at a lower price than the original one: the owner of preferred stock then gets to convert their share according to how much they would own had they bought it at the new price.
Sometimes the new stock is first offered to shareholders with preemptive rights for a lower price than it will later be offered to the public. Selling stock to shareholders with preemptive rights is also much cheaper for the company since they do not have to rely on any investment banking services as they would have to for a public offering.
Preemptive rights are commonly used as incentive for early investors since they risk more by investing money in an unproven company. It is somewhat similar to a right of first refusal since the holder of preemptive rights is not obliged to purchase more stock. On the side of the company it serves as incentive to perform well so that they can offer the next round of stock at a premium.
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Disclaimer: This overview is for informational purposes only and cannot be counted as legal advice.