Definition of Preemptive Right
Preemptive rights refer to shareholders who possess the right to maintain some share of ownership of an organization through the buying of the proportional number of shares to the percentage of shares they already have in the corporation. The stockholder has the right to buy some additional shares in the company of new issues for Equity preservation. This is done before anyone else can purchase shares of a new issue for equity preservation.
Preemptive right is a contract that is binding between the buyer and the company. The preemptive right states that the investor who invests large chunks of capital to a startup by buying large amounts of shares, they should have equal voting power and voting rights in the later stages as they had when they purchased shares in the beginning.
Example of Preemptive Right
Let's say company ABC has a total of 100 outstanding stock shares. If you own 10 shares in the company, then you have possession of 10% of the shares and the company. In order to raise capital, directors of the board decided to sell yet another 100 shares within the company for another $50 per share. Without the preemptive right, this could dilute 5% of your shares, i.e. 10 shares that is divided by 200 outstanding shares. With the help of your preemptive right, you choose to buy back the 10 shares of the new stock. So you have to pay $500 in total, , i.e. 10 shares multiplied by $50 each. So the total comes to $500. So now you have 20 shares out of a total of 200 outstanding shares. This is same as 10% as before.
Preemptive rights can at times become inconvenient when converting them from equity to cash. Thus many companies choose to stay away from preemptive rights. Under the Companies Act of 2006 in England and Wales, companies cannot issue shares to people unless and until an offer has been made. The time limit of the the share acceptance for the shareholder has expired. Usually the offer for acceptance stands for a period of 14 days.