Pre-emptive right

Hello startup superstars,

we have to be honest with you. The whole “New Year, new me” phrase doesn’t really apply to us. We value consistency - and that’s why we’re back with our newsletter devoted to explaining key legal terms to startup enthusiasts.

Today, we’re launching a new miniseries on investor rights in the context of negotiating a term sheet - starting with pre-emptive right.

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What’s a pre-emptive right?

Simply put, shareholders with a pre-emptive right can buy new company stock before it’s offered to others. Why? To protect these shareholders against dilution in both share value and voting power in the company.

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Why does this matter?

Pre-emptive right protects current shareholders against dilution of their ownership. When the company issues shares to new investors, current shareholders’ ownership decreases due to dilution. Pre-emptive right lets shareholders maintain their ownership percentage by enabling them to buy new stock before it gets offered to others.

Pre-emptive right usually applies to the extent of current ownership (pro rata). So, for instance, if a shareholder owns 5 % of the company, the pre-emptive right would allow them to buy up to 5 % of new shares.

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It’s usually used as an incentive for early investors in return for the risk they undertake by investing in a brand new venture.

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Dos and don'ts

Navigating the pre-emptive right can be tricky, but we’ve got some simple tips to help you.

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In a nutshell

‍Granting pre-emptive rights can be a win-win. It can stimulate capital inflow to early-stage companies while enabling investors to keep a stable ownership percentage over time.

If you want to chat more about maintaining a healthy balance between company needs and investor interests, reach out to our team anytime and follow us on LinkedIn for more insights.

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Until next time!