Preemptive Rights
What does "Preemptive Rights" mean in law?
Preemptive rights give existing shareholders the right to purchase a proportional share of any newly issued stock before it is offered to outside investors, thereby protecting shareholders from dilution of their ownership percentage and voting power. Under older corporate statutes, preemptive rights existed as a default rule unless the articles of incorporation opted out; under modern statutes such as the Revised Model Business Corporation Act, preemptive rights exist only if the articles of incorporation affirmatively include them. The scope of preemptive rights can be complex, as they may or may not extend to treasury shares, shares issued for non-cash consideration, or shares issued under employee compensation plans. Preemptive rights are particularly important in closely held corporations where dilution can fundamentally alter the balance of control among a small number of shareholders.
Definition
Preemptive rights give existing shareholders the right to purchase a proportional share of any newly issued stock before it is offered to outside investors, thereby protecting shareholders from dilution of their ownership percentage and voting power. Under older corporate statutes, preemptive rights existed as a default rule unless the articles of incorporation opted out; under modern statutes such as the Revised Model Business Corporation Act, preemptive rights exist only if the articles of incorporation affirmatively include them. The scope of preemptive rights can be complex, as they may or may not extend to treasury shares, shares issued for non-cash consideration, or shares issued under employee compensation plans. Preemptive rights are particularly important in closely held corporations where dilution can fundamentally alter the balance of control among a small number of shareholders.
Example
When the corporation decided to issue 1,000 new shares to raise capital, a shareholder holding 25% of the outstanding stock exercised her preemptive rights to purchase 250 of the new shares, maintaining her proportional ownership interest and voting power.