Pre-emption rights: A guide for companies and shareholders

Pre-emption rights may sound perplexing, but they serve a simple yet critical purpose: to protect shareholders’ ownership stakes when a company issues new shares or when existing shares are sold. 

In effect, pre-emption rights protect shareholders from unfair dilution. They allow shareholders to maintain their percentage ownership in the company if they choose to exercise their rights and buy the new shares being issued. 

As companies grow and raise further investment, shareholders may not always have the financial means to maintain their ownership percentage. 

Natural dilution goes hand in hand with business growth, and is certainly not always a bad thing. A smaller percentage of a more valuable company can be worth much more than a larger slice of a less valuable one.

Pre-emption rights simply ensure shareholders have the choice: they can maintain their percentage ownership as the business grows if they want to and are able to do so.

Read on as we demystify pre-emption rights, explore how they work in practice, and explain how they keep everyone on a level playing field.

How do pre-emption rights work?

Pre-emption rights are a key feature of company law under the Companies Act, designed to protect existing shareholders from having their ownership diluted. 

At their most fundamental, they give shareholders the first chance to buy new shares when they're issued.

There are two main ways pre-emption rights are applied:

1. Statutory rights under the Companies Act 2006: The Companies Act enforces pre-emption rights in certain scenarios, such as when new equity shares are issued for cash. These rights are legally binding unless shareholders vote to disapply them through a formal resolution.

2. Rights in a company's articles of association: The articles of association outline a company's internal rules, and pre-emption rights may be included here, too. 

   If the company uses the model articles – the default rules provided under company law – pre-emption rights are built in through Regulation 21. This regulation grants existing shareholders the first opportunity to buy newly issued shares.

Statutory pre-emption rights offer baseline protection for shareholders, ensuring fairness in cash-funded share issues. 

Rights included in a company’s articles go further by addressing additional scenarios and embedding protections into the company’s governance structure.

While their origins differ, both statutory and article-based rights are legally binding and equally enforceable.

The former is a baseline established by the Companies Act 2006, while the latter functions as a 'statutory contract' that binds the company and its members once embedded in the Articles of Association.

Together, they create a comprehensive system for managing ownership and preventing unwanted dilution.

If a company has custom articles of association, pre-emption rights may be modified or excluded entirely, depending on how those rules are written. 

Pre-emption rights: When your company issues new shares

Under the Companies Act 2006, shareholders have statutory pre-emption rights on new equity securities issued for cash. 

So, if a company issues 1,000 new shares and you own 25%, you’d have the right to purchase 250 of them before they’re offered to others. However:

• These rights only apply to cash issuances, not shares issued in exchange for non-cash consideration, such as assets or services.

• Companies can modify or remove these rights in their articles of association, subject to approval by a special resolution (requiring 75% of shareholders' agreement).

• Shares issued under employee share schemes are generally exempt from pre-emption rights, making it easier for companies to allocate shares to employees as part of incentive plans.

Pre-emption rights: When someone wants to transfer existing shares

The Companies Act 2006 doesn’t automatically provide pre-emption rights when a shareholder wants to transfer their existing shares to an external party. 

Instead, these rights must be specifically included in the company's articles of association or shareholders' agreement.

If pre-emption rights are included for share transfers, the process typically works like this:

1. The shareholder who wants to sell their shares must first offer them to the existing shareholders.

2. The existing shareholders then have the opportunity to purchase the shares in proportion to their current shareholding.

3. If the existing shareholders choose not to exercise their pre-emption rights, the shares can then be offered to external buyers.

This process helps to protect the existing shareholders by giving them the first chance to maintain their ownership proportion and control over the company.

Vestd's standard articles of association automatically include pre-emption rights for share transfers. So if your company adopts our articles, your shareholders will benefit from these protections whenever a share transfer is proposed.

Pre-emption rights: Flexibility and waivers

“Rights” is the operative word here. Pre-emption rights are a protective privilege for shareholders, not a mandatory obligation; as such, they can be waived to suit the company’s needs.

However, the mechanism for doing so depends entirely on whether you are dealing with a share issuance (newly created equity) or a share transfer (selling existing equity).

1. Share issuance 

For the allotment of new shares, pre-emption is a statutory right. These rights can be disapplied through a Special Resolution, which requires the approval of shareholders holding at least 75% of the company’s voting rights.

It is a common misconception that this ‘turns off’ pre-emption for the entire company. 

In reality, a special resolution to waive pre-emption applies only to the specific shares mentioned in that resolution, unless the company’s Articles of Association are permanently amended to remove the right entirely.

2. Share transfers

Unlike a new issuance, pre-emption on the transfer of existing shares is not a statutory right. Instead, it is a contractual right typically embedded in a company’s Articles of Association or a Shareholders' Agreement.

Because these rights are contractual rather than statutory, they do not follow the same universal 75% rule. 

The waiver mechanisms are subject to the specific terms of your company’s governance documents. In many cases, this requires a formal "Waiver Letter" or "Deed of Waiver" signed by each individual shareholder, rather than a top-down resolution.

Wavering pre-emption rights aren’t something to take lightly. It’s only recommended when there's a compelling reason to do so. Overusing waivers can undermine the very shareholder protections that pre-emption rights are meant to provide.

Why do pre-emption rights matter?

Pre-emption rights matter because they put shareholders in control of their investments. They're particularly valuable in three key situations:

1. When your company is raising money 

Without pre-emption rights, a company could issue a heap of new shares to others, dramatically reducing your percentage ownership – and therefore your share of future profits and your voting power. 

Pre-emption rights ensure you get the chance to maintain your position by buying your proportion of any new shares being issued.

2. When a co-owner wants to sell 

What if one of your co-shareholders wanted to sell their shares to your biggest competitor? 

Pre-emption rights mean you and your fellow shareholders get first refusal on those shares. This helps you keep control over who owns part of your company.

3. When returns are on the horizon

After years of investing time and money into a company's success, the big payoffs often come through dividends, company sales, or big investment rounds that lead to increased valuations.  

Pre-emption rights protect your slice of these returns by ensuring you can maintain your percentage ownership when new shares are issued. 

Without them, a share issue could cut your stake ahead of the company's value being realised.

Let's look at a real-world example

Say you own 25% of a company valued at £1 million, making your stake worth £250,000. 

The company needs to raise £500,000 by issuing new shares. Without pre-emption rights, these new shares could be issued to others, diluting your stake to 16.7%. 

With pre-emption rights, you get the chance to invest £125,000 (25% of the new investment) to maintain your 25% stake.

Of course, you might choose not to take up your pre-emption rights – perhaps you don't have the funds available, or you're happy to be diluted. That's fine – the choice is yours.

How pre-emption rights affect shareholder decisions

As a shareholder, the way in which pre-emption rights affect you depends on your company's articles. Under the default statutory rights for new issues:

• The company must offer new shares to all existing shareholders
• The offer must be in writing, stating how many shares are available and their price
• You have the right (but not obligation) to buy your proportion of the new shares
• Your proportion matches your existing share of the company's relevant share class
• You must be given at least 14 days to respond

However, the process for transferring pre-emption rights depends entirely on your articles. 

Typically, the selling shareholder must notify the company of their intention to transfer. The company then offers these shares to other shareholders, often:

• In proportion to existing holdings, or
• Equally among interested shareholders, or
• In any other way specified in the articles

Check your company's articles – they'll set out exactly how the process works, including any special provisions or exceptions that might affect your rights.

How pre-emption rights affect companies

Managing pre-emption rights is an important aspect of company governance. 

Every share issue or transfer needs careful handling to protect shareholder rights and maintain compliance. This typically involves:

• Reviewing your articles to confirm exactly what rights apply
• Calculating shareholder entitlements accurately for each share class
• Issuing formal notices with all required information
• Managing timing requirements (both statutory and articles-based)
• Handling responses and payments properly

Messing up the above processes can lead to invalid share issues or transfers and even strain relationships with your shareholders. It’s a slippery slope you want to avoid. 

On the brighter side of the equation, handling pre-emption rights transparently keeps transactions smooth, protects relationships, and ensures your company stays on the right side of the law.

Managing pre-emption rights effectively

Share management should be straightforward. That's why we created articles of association that make pre-emption rights work better for everyone involved.

Most companies adopt our articles when they join Vestd because they turn complex share processes into something much more manageable without compromising on important shareholder protections.

Here's how they work:

• The articles give you a clear, practical system for handling both new shares and transfers
• When you issue new shares, existing shareholders get first refusal in proportion to their current holdings
• Want to transfer shares? No problem – you can do this easily with board approval
• For other transfers, existing shareholders get first dibs, keeping you in control of your cap table
• Need flexibility for investment? 75% of shareholders can agree to remove these rights for specific shares

We know managing shares properly matters. Our platform takes care of the admin heavy lifting by handling your documentation, tracking responses, maintaining records and managing Companies House updates. All automatically, all in one place.

Want to see how we can help you manage shares more effectively? Book a free chat with our team.

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