a boardroom table with the heading 'pre-emption rights of shareholders'." width="1500" height="750" />a boardroom table with the heading 'pre-emption rights of shareholders'." width="1500" height="750" />
Shares and Shareholders 6 Min Read
Last updated: 26 Apr 2023Pre-emption rights give the shareholders of a company first refusal to purchase any new or existing shares that become available. These rights are designed to protect the interests of shareholders and limit the ability of third parties to hold shares in a company.
If you own shares in a limited company, it is of great importance to determine whether the articles of association or shareholders’ agreement provide pre-emption rights – and, if so, to what extent. This post explains why.
Pre-emption rights, or the right of pre-emption, is the ‘right of first refusal’ on the allotment or transfer of shares.
If a company provides these rights, the existing shareholders must be given the chance to buy available shares relative (pro-rata) to their current proportion of shareholdings, before those shares are offered to anyone else.
For example, if a shareholder owns 25% of the company’s shares, and that company has pre-emption rights, the shareholder has the right of first refusal on 25% of:
Providing these rights protects existing shareholders against involuntary dilution of their current ownership stake, which would directly impact their profit entitlement and voting rights. This helps to maintain the balance of power between members, and is particularly beneficial to minority shareholders.
Without such restrictions in place, majority shareholders could issue additional shares to themselves at a lower valuation, without offering the same favourable terms to minority shareholders.
The right of pre-emption is also a useful control mechanism for shareholders to restrict the ability of external investors or unsuitable parties to become involved in the company.
However, where pre-emption rights exist, shareholders are under no obligation to purchase any shares that become available. It is entirely optional, and they can choose to refuse any such offer by waiving their right of pre-emption at that time.
The Companies Act 2006 provides statutory pre-emption rights to shareholders (members) on the allotment of new shares, but not on the transfer of existing shares.
If a company issues new shares, it must communicate the offer to existing shareholders in hard copy or electronic form, specifying a period of at least 14 days during which the offer may be accepted.
With limited exceptions, these statutory pre-emption rights will apply to the allotment of new shares, unless the company chooses to waive the rights on a particular allotment, or disapply the rights entirely in its articles of association or a shareholders’ agreement.
In some companies, the board of directors may have the authority to disapply pre-emption rights in certain circumstances, by passing a board resolution. This can take place at a board meeting or remotely as a written resolution.
However, the decision to amend the articles to remove these rights can only be made by special resolution of the members. To pass a special resolution, at least 75% of the members’ votes must be cast in favour of the motion, either at a general meeting or by written resolution.
Many companies, however, provide enhanced pre-emption rights in bespoke articles and/or a shareholders’ agreement, ensuring better protection for all shareholders and the company as a whole.
Whatever the case, no issue or transfer of shares should be made without first consulting the provisions set out in the company’s articles and, if applicable, the shareholders’ agreement.
Existing shareholders’ statutory rights of pre-emption on the issue of shares do not apply in the following circumstances:
Additionally, the rights do not apply on a specified allotment once a shareholder waives their right to take up the offer.
Neither the Companies Act 2006 nor the Model articles of association provide the right of pre-emption on the transfer of shares from a current member to a third party.
This means that, under the Model articles, shareholders are free to sell or gift their shares to any person of their choosing, including other existing shareholders, family members, or external investors.
Whilst share transfers require the approval of the company directors, members are under no legal obligation to first offer their available shares on a pro-rata basis to the other members of the company.
This can be problematic and lead to shareholder disputes, which is why many companies include additional provisions on pre-emption rights in bespoke articles of association or a shareholders’ agreement.
Some of the most common types of pre-emption rights and restrictions that private companies may include in one or both of these important company documents include:
Companies may also specify procedures for offering available shares to existing members that differ from the statutory procedure set out in the Companies Act. For example, the way in which pre-emption offers are communicated, or the time limit that a member has to accept or refuse the offer to purchase available shares.
Pre-emption rights are one of the most common features in bespoke articles and shareholders’ agreements, highlighting their importance in any business venture involving two or more shareholders.
It is vital that a company’s articles and shareholders’ agreement are properly drafted to reflect the particular needs of the company and the interests of all members. If pre-emption rights are included, great care must be taken to ensure that the provisions in both documents are identical.
Whilst pre-emption rights afford existing shareholders greater protection and control over the business, there are certain disadvantages to be aware of.
The right of first refusal puts restrictions on the freedom of shareholders to transfer their shares to parties of their choosing. It can also limit a company’s ability to raise capital from external investors as a means of growing the business.
Moreover, the requirement to offer available shares to every shareholder can be time-consuming and expensive. This can delay fundraising or the exit of a shareholder who wishes to leave the company.
Shareholders can waive their pre-emption rights, and refuse an offer to buy shares that become available through an allotment or transfer. Doing so has no impact on their ability to take up any future offer of shares.
Similarly, unless the articles or shareholders’ agreement contains provisions to the contrary, the company can disapply pre-emption rights in certain situations by passing a board resolution or a special resolution of the members. Companies may choose to do this to raise capital from third-party investors.
Alternatively, members can pass a resolution to amend the articles and/or shareholders’ agreement to permanently remove all rights of pre-emption. Doing so, however, can have negative consequences, not least for minority shareholders.
If you are setting up a company with at least one other shareholder, you should give careful consideration to pre-emption rights and the level of protection you wish to provide for yourself and other members.
Statutory pre-emption rights may be suitable for some companies, but it is often beneficial to all members and the business as a whole to include additional rights in bespoke articles or a shareholders’ agreement.
Doing so will prevent the involuntary dilution of your profit entitlement and voting rights upon both the allotment and transfer of shares. It will also help to preserve the status quo of the company’s membership, by restricting the ability of unsuitable third parties to become shareholders.
Pre-emption rights can be complex, so we would advise speaking to a solicitor to establish which rights are best suited to your company.
If you have any questions about this topic or need help setting up a company, please leave a comment below or contact our company formation team online or by telephone.
Mathew Aitken, Senior Content Writer at 1st Formations, has over 15 years of experience writing about small business and in particular, company formations. He is passionate about simplifying seemingly complex processes. In his spare time, Mathew is a keen runner, film lover and Tottenham Hotspur fan.
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