What is a Preemptive Right?

//What is a Preemptive Right?
What is a Preemptive Right? 2017-10-09T05:51:05+00:00

Definition: A preemptive right is a stockholder’s right to maintain his or her ownership percentage in a corporation as the company issues additional shares of stock to new investors. In other words, this right allows current shareholders to purchase their proportionate number of shares in any new stock offering in order to maintain their ownership in the company. Without this right, their ownership share would be diluted every time additional investors were allowed to buy into the corporation.

What Does Preemptive Right Mean?

The preemptive right to purchase additional shares is one of the most basic common shareholder rights in a corporation. Since common stock shareholders have the right to vote at meetings, elect the board of directors, and ultimately sway the future of the company, they have a keen interest in making sure their ownership percentage isn’t diluted.

Let’s take a look at an example.

Example

Let’s assume that Kyle is a 51 percent owner of Kyle’s Footwear, Inc. This footwear and apparel company has several store locations and multiple other investors. In order to finance another location, Kyle’s Footwear has decided to issue 1,000 new shares to investors.

Since Kyle is a 51 percent owner of the corporation, he has the right to purchase 51 percent of the newly issued shares. This right is called a preemptive right because Kyle can preemptively stop other investors from purchasing these shares. This is Kyle’s right; however, it is not an obligation. Kyle does not have to purchase all or even some of the newly issued shares. If Kyle decides not to exercise his right to maintain his ownership percentage, his interest in the company will decrease in proportion to the other investors and he will no longer own the controlling interest of the company.

Corporate takeovers and major changes in shareholder ownership often revolve around this concept.