When running a company, one question that often comes up is: “What happens if we want to issue more shares, or someone wants to sell theirs?”
This is when pre-emption rights come into play.
These rights are an important legal safeguard that give existing shareholders the first opportunity to buy new or transferred shares before they’re offered to outsiders. They help maintain balance, protect ownership stakes, and ensure transparency. In this article, we’ll break down what pre-emption rights mean, how they work, and why they matter to shareholders.
What exactly are pre-emption rights?
Put simply, pre-emption rights are a shareholder’s right of first refusal. If new shares are being issued or existing shares are being sold, shareholders with pre-emption rights get the first chance to buy them in proportion to their existing holdings and often at fair value. This is especially important in private companies, where keeping control of who becomes a shareholder is often vital to the continuity and success of the business.
Where do pre-emption rights come from?
There are primarily two sources of pre-emption rights, the articles of association of the company and the Companies Act 2006. There might also be pre-emption rights in a Shareholders’ Agreement.
Pre-emption Rights on creation of new shares (allotment)
Under the Companies Act 2006, subject to some exceptions, if a company has issuing shares for cash, it usually has to offer them to existing shareholders first.
For instance, if you own 25% of a company, and it wants to issue 1,000 new shares, you should be offered 250 of them before they’re offered to anyone else.
These rights apply automatically, unless the company’s articles of association or a shareholders’ resolution disapplies them.
If a company wants to have different pre-emption rights, then these can be included in its articles of association.
Pre-emption rights on share transfers
Unlike the allotment of new shares, pre-emption rights on the transfer of existing shares aren’t covered by statute. Instead, they’re typically built into the company’s articles of association or a shareholders’ agreement.
The default Model Articles used by many private companies do not include pre-emption rights. So, if you want this protection in place new articles of association need to be adopted.
Having pre-emption rights on the transfer of shares gives all shareholders the opportunity to keep the company’s ownership within the current group.
Can pre-emption rights be disapplied?
Companies can choose to disapply pre-emption rights either temporarily or permanently by way of special resolution of the shareholders (requiring 75% approval).
However, disapplying these rights without proper consultation can lead to disputes, so transparency is key.
Do pre-emption rights apply on the death of a shareholder?
Following the death of a shareholder usually the shares are transferred to a beneficiary or to the personal representatives of the deceased. Normally, a different right applies in this circumstance called ‘transmission’ and a different process applies. However, as this right is contained in the articles of association of the company, the shareholders can decide how this should work.
Why do pre-emption rights matter?
Pre-emption rights are more than just legal jargon , they’re a practical way to:
- Protect existing shareholders from dilution,
- Maintain control over who becomes a shareholder,
- Provide a mechanism for an exit of a shareholder.
For directors, it’s essential to understand and follow these rules to avoid breaching duties.
For shareholders, knowing your rights can help you make informed decisions and protect the value of your shareholding in the company.
Final Thoughts
Whether you’re a founder, investor, or advisor, understanding pre-emption rights is crucial for navigating share issues and transfers in companies.
If you are considering putting pre-emption rights in place, or updating your company’s documents, it’s a good idea to get professional legal advice to ensure everything is tailored to your company’s needs and goals. If you would like to discuss the pre-emption rights for your company, please contact our Corporate and Commercial Team on 0116 289 7000.