When a corporation raises capital through the sale of capital stock or securities convertible into shares of stock, it may be required by law or its corporate charter to offer the securities to its shareholders before offering them to other investors. The right of existing shareholders to buy shares in a new issue of capital stock of the same company in proportion to their ownership interest before the shares are offered to other investors is a preemptive right. Although mandatory in some US states and European jurisdictions, preemptive rights are frequently not granted to the shareholders of US corporations.
|Under the UK Companies Act 2006|
|Pre-emptive rights do not apply if:|
|(a) the memorandum or articles of a private company exclude them; or|
|(b) the company passes a special resolution to exclude them; or|
|(c) the shares are issued for noncash consideration.|
The preemptive right of existing shareholders protects them from the dilution of control otherwise resulting from a new issue of voting stock. If existing shareholders were not able to purchase a proportionate share of a new issue by the company, their ownership interest in the company would be diluted, thereby reducing their voting percentage as well as their earnings and the net worth per share.
|Example of Preemptive Rights Exclusion of a US Company|
|“Holders of the capital stock of the Company shall not be entitled to preemptive rights with respect to any shares of the Company which may be issued.”|
|Source: Law Insider|