When it comes to issuing or transferring shares, pre-emption rights can serve as a key protection for existing shareholders. It provides the opportunity to prevent dilution of their shareholdings and potentially keep unwanted third parties or indeed existing shareholders from acquiring shares (or further shares) and gaining influence (or more influence) in the company.
B P Collins’ corporate and commercial team explores the different types of pre-emption rights for private companies and their practical implications in more detail.
What are pre-emption rights?
Pre-emption rights are essentially a right of first refusal. They can apply to:
1) the issue of new shares and/or
2) the transfer of existing shares.
Depending on which of those apply, they give existing shareholders the first opportunity to buy new shares and/or shares being transferred, before they are offered to the intended buyer of those shares.
Certain pre-emption rights are set out under the Companies Act 2006 (“Statutory pre-emption rights”), but companies can choose to exclude such rights or adopt bespoke pre-emption rights in their articles of association and/or shareholders’ agreement (“Contractual pre-emption rights”).
Statutory pre-emption rights:
Unless they have been excluded or amended (which can be done by way of special resolution), statutory pre-emption rights apply when a company allots and issues new shares (N.B. this only applies to “ordinary” shares as defined by the Companies Act 2006). Before issuing such shares to the intended buyer, the company must first offer them to all existing holders of ordinary shares on the same, or more favourable, terms as the terms on which they want to offer the shares to the intended buyer.
Each shareholder must be offered a proportion of the new shares that matches their existing percentage of the company’s ordinary share capital. There are specific rules regarding how the offer is communicated and the time allowed for shareholders to respond.
If, at the end of the statutory pre-emption process, any shareholders choose not to take up their entitlements, the directors may then issue the remaining shares to the intended buyer.
Contractual pre-emption rights:
The Companies Act 2006 does not provide for pre-emption rights on the transfer of existing shares. To afford the protection these rights offer to existing shareholders, companies typically include a pre-emption provision in respect of share transfers in their articles of association or their shareholders’ agreement.
Similar to statutory pre-emption rights, contractual pre-emption rights operate by prohibiting the transfer of shares to an intended buyer unless the shares are first offered to existing shareholders, in proportion to their current shareholdings. If a shareholder does not wish to purchase the shares, or lacks the funds to do so, they may renounce their right, allowing the shares to be transferred to the intended buyer (often provisions are included to require that those surplus shares must first be offered to the other shareholders and/or the company itself).
If none of the shareholders wish to exercise their pre-emption rights in relation to a particular share transfer, they can waive those rights by unanimous consent, avoiding the pre-emption process altogether.
Points to keep in mind
It’s worth bearing in mind that pre-emption rights are only useful if and to the extent that the existing shareholders have the money to buy the shares.
Also, while the articles of association or shareholders’ agreement may give shareholders pre-emption rights over share transfers, those agreements may contain other provisions which override those rights. These will typically include:
- “drag along rights” whereby a certain majority of the shareholders can accept an offer to buy their shares and force the remaining shareholders to also sell their shares on the same terms, without first having to follow the pre-emption process (for more information on drag along rights, please click here ; and
- a right for shareholders to transfer their shares to certain “permitted transferees”, usually close family members of individual shareholders and group companies of corporate shareholders, free of any pre-emption rights.
From helping founders seeking to put in place safeguards for their existing shareholdings, directors needing assistance to comply with a pre-emption process, to exiting shareholders facing statutory or contractual pre-emption rights, our corporate and commercial team at B P Collins is here to help.
Please email enquiries@bpcollins.co.uk or call 01753 889995 to get in touch. Our experienced lawyers can support you in drafting, reviewing, or enforcing these important provisions.
