Pre-emption Rights Explained

Posted 12 Jan 16

When forming a limited company, you will need to nominate its shareholders and directors, as well as, make a decision regarding the shares.

In the majority of cases, during the first year of a small company activity, it is the owner him/herself who takes the role of its sole director and shareholder. However, depending on the intentions you have regarding your business, you might nominate more shareholders and issue a larger amount of shares.

Although there is no limited number of shares you can issue during or after incorporation, it differs depending on your future business aims. If you do not plan to be approached by outside investors, you might decide to have only one shareholder and only one share, owning 100% of your business.

If you, however, issue an even number of shares when registering your limited company, it will give you the opportunity to transfer existing shares to other people in exchange for capital.

All decisions regarding a company’s shares are made based on the articles of association and shareholders’ agreement. One of the things you can include in the articles of association and shareholders’ agreement is pre-emption rights.

Pre-emption rights are any rights shareholders have to obtain available shares in proportion to their current shareholding. Pre-emption rights is the way in which a company protects the rights of its existing members (shareholders) by keeping the internal structure of the business stable. With pre-emption rights, a company cannot offer its shares to other potential investors without first offering them to existing shareholders.

How can I include pre-emption rights?

Pre-emption rights can arise from these sources:

statutory pre-emption rights

pre-emption rights within the company’s articles of association

pre-emption rights under a shareholders’ agreement

The statutory pre-emption rights are based on the Companies Act 2006. They apply by default and state that the dividend paid varies dependent on the company’s profits, however, have no special rights to capital repayment in case the company is wound up.

Pre-emption rights can be alternated or disapplied by a company’s articles of association.

Limited company members have a right to add pre-emption rights to the articles during the company formation process, or afterwards through a special resolution at a general meeting or in writing.

The agreement regarding this decision arises when at least 75% of shareholders’ voters are in favour of it passing. The articles should include the pre-emptive procedure that the company must follow.

Pre-emption rights can be also removed from the articles at any time after company registration. They can be disapplied through a special resolution and followed by the immediate update of a shareholders’ agreement.

Waiving pre-emption rights

A shareholder has a right to waive his or her pre-emption rights for any reason. Only then, a company shares can be sold to outside investors. The changed decision must be updated in the articles of association.

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