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Corporations • Stock Issuance
CORP#023
Legal Definition
Preemptive rights are the rights of an existing shareholder to maintain his percentage of ownership by purchasing stock whenever the corporation issues new stock for cash. Preemptive rights do not exist unless expressly granted by the articles of incorporation.
Plain English Explanation
Ownership of a corporation is represented by the number of shares it has and who owns them. If HypoCorp has a total of 20 shares, and Bob owns 5 of them, then Bob controls 25% of HypoCorp. But what would happen if HypoCorp wanted to raise more money by issuing 20 additional shares of stock? This would increase the total number of shares to 40, which means Bob's 5 shares of stock would now only represent 12.5%. In other words, the power of Bob's 5 shares is diluted.
If Bob were interested in maintaining 25% control of HypoCorp, he would need to purchase 5 additional shares, bringing his total ownership to 10 shares out of the 40.
With that in mind, preemptive rights are a way to facilitate this desire from shareholders to maintain their percentage of power. They basically say, "Hi, Corporation. It's cool if you want to issue more shares, but you have to let me preemptively purchase whatever number of shares is necessary to maintain my percentage of ownership over you."
Under common law, preemptive rights existed by default. However, under modern statutes, they do not exist unless they were created and defined in the articles of incorporation when the corporation was first created.
If Bob were interested in maintaining 25% control of HypoCorp, he would need to purchase 5 additional shares, bringing his total ownership to 10 shares out of the 40.
With that in mind, preemptive rights are a way to facilitate this desire from shareholders to maintain their percentage of power. They basically say, "Hi, Corporation. It's cool if you want to issue more shares, but you have to let me preemptively purchase whatever number of shares is necessary to maintain my percentage of ownership over you."
Under common law, preemptive rights existed by default. However, under modern statutes, they do not exist unless they were created and defined in the articles of incorporation when the corporation was first created.
