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Pre-emptive Rights of the Shareholders


Authored by - Thejuswini

Keywords - Pre-emptive rights, shareholders, basic right, company, benefits, types.


Abstract


A common shareholder has a total of six rights available to him within a company. Out of these six rights, Pre-emptive right is one right. As it is considered to be a basic right and an important right of the shareholders, it is quite essential to know about the concept of Pre-emptive rights and the different types of Pre-emptive rights existing. This article shall also seek to define how beneficial these rights are to the company and the shareholders both.


Introduction


This article deals with the definition and meaning of a contractual clause known as pre-emptive rights. These rights are made available to the shareholders, who are already existing in companies. This right ensures that there is no dilution of ownership percentage owned by the existing shareholders within the company. In addition to this, this article also deals with the advantage of exercising this right as well.


Meaning: Pre-emptive Rights


« It is considered to be one of the common rights available to a shareholder within a company.[1]

« It is a right that enables the shareholders to purchase additional shares.

« Hence, we could understand pre-emptive right as a right that has the capability and capacity to help the already existing shareholders in purchasing additional shares and these shares in turn help them in maintaining their ownership percentage within a company or corporation. When the corporation provides a share of stock to new investors.[2]

« Pre-emptive rights are also known as Dilution provision as it ensures that the ownership percentage of the existing shareholders is not diluted. In other words, this right helps in maintaining the ownership percentage.

« The Pre-emptive right is not available to all shareholders. This share is mostly provided to the existing shareholders.


Types of Pre-emptive Rights


Weighted average and Ratchet are different types of pre-emptive rights.[3]

· Weighted average

This provides the shareholders with a right to purchase shares at a newly offered price by considering a change in the old price.

· Ratchet

The shareholders are given a chance to buy shares at a new lower price.


Advantages of Pre-emptive Rights[4]


The advantage to the company


« It is very cheap for a company when it comes to selling shares to its current or existing shareholders than selling it to the public as a whole.

« It saves a company from making huge payments to investment banking services.

« This right also reduces the cost of equity of a company and increases the value of the firm.

« It helps in making the performance of the company much better which further results in the issuance of new round stock of higher valuation whenever it is needed.

Advantage to the shareholders

« It helps a shareholder to retain the ownership percentage within the company without getting diluted.

« In case there is a new issue at a lower price then the shareholder can subsequently convert the preferred stock to more shares.[5]


Conclusion


The concept though acts more advantageous to both the shareholders as well as the company, it is not free from disadvantages. If Pre-emptive rights are granted then a company will not be able to locate new individual investors and negotiate with them in a flexible manner. It is not possible to limit the ownership percentage of the shareholders, especially when pre-emptive rights are provided. Moreover, it can turn into a burden as it will not easily let a company raise its funds[6] when the existing shareholders ask for information regarding the recent equity rounds so that they could ask for their pre-emptive rights.[7] Thus, pre-emptive right is both advantageous as well as disadvantageous. Hence, the companies have the authority to decide whether the pre-emptive right is to be made available to the shareholders or to waive off the same. If they have to waive off this particular right, then they should make sure that the changes regarding the same are made in the articles of incorporation of the company.[8]


References

  1. My Accounting Course, What is a Preemptive Right?, https://www.myaccountingcourse.com/accounting-dictionary/preemptive-right,(last visited 15 Sep. 2020)

  2. Slav Fedorov, What Is the Preemptive Right of Common Stockholders?, https://pocketsense.com/preemptive-right-common-stockholders-4729.html , (last visited 17 Sep. 2020)

  3. Wall Street Mojo, Preemptive Rights, https://www.wallstreetmojo.com/preemptive-rights/, (last visited 16 Sep. 2020)

  4. Carli Tardi, Preemptive Rights, https://www.investopedia.com/terms/p/preemptiveright.asp, (last visited 15 Sep. 2020)

  5. Investing Answers, Preemptive Rights, https://investinganswers.com/dictionary/p/preemptive-rights, (last visited 16 Sep. 2020)

  6. Joshua Kennon, Understanding Shareholders' Preemptive Rights, https://www.thebalance.com/what-is-the-preemptive-right-358100, (last visited 16 Sep. 2020)

  7. Upcounsel, Preemptive Rights: Everything You Need to Know, https://www.upcounsel.com/preemptive-rights , (last visited 17 Sep. 2020)

  8. Indian Kanoon, Mr. N. R. Harikumar vs Ww Apparels (India) Private https://indiankanoon.org/doc/102470590/#:~:text=A%20statutory%20right%20can%20be%20waived%20subject%20to%20certain%20conditions.&text=Therefore%20it%20is%20the%20stand,1956%20can%20also%20be%20waived. , (last visited 15 Sep. 2020)

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