What is a Pre-Emptive Right?

A pre-emptive right, sometimes known as a subscription right or a call option, is a right that belongs to the shareholders of a corporation. It is meant to protect both the value of their shares and their ownership interests in the corporation. A pre-emptive right temporarily limits access to a corporation’s available stocks by giving priority to pre-existing shareholders. In other words, the purchasing power of the shareholders comes before that of the general public or the corporation’s management.

Generally, a share is a basic unit that represents a portion of a company’s earnings and assets. Once a person purchases at least one share of a company — also known as a stock — he or she owns a portion of those earnings and assets. Technically, the company is the property of the shareholders. As such, there are certain rights that have been developed to protect a shareholder’s claim to his or her property. A pre-emptive right is one such right.

The rights of shareholders are not the same for every company or for every region. Although many companies follow a general model, each company decides upon and drafts its own corporate charter, which is a document that enumerates its specific rules, regulations, and by-laws. A charter determines protocol for items such as pre-emptive rights. Once a person purchases stock and becomes a shareholder, he or she could consult the corporate charter and local laws to learn about what rights are prescribed.

Pre-emptive rights are relevant when there is stock that has recently been made available, and this usually occurs in one of two ways. The first way is when a company issues new stock. When the management of a company decides it is in the company’s best interest, it will make new stocks available to the public. A shareholder will receive a letter and will be given a certain amount of time, usually between 30 and 60 days, to decide what to do.

The second way in which stock can be made available is when one shareholder independently decides to sell his or her stock. Much like the process of new stock issuance and its concomitant pre-emptive right, when a shareholder decides to sell stock, the other shareholders have a right known as the right of first refusal. The right of first refusal demands that the shareholder selling the stock give priority to pre-existing shareholders over any other third party.

Pre-emptive right, the right of first refusal, and other similar rights are related. By having the purchasing freedom afforded by the pre-emptive right, and rights like it, shareholders are able to purchase an appropriate amount of shares in order to prevent the devaluation of their stocks and to maintain a proportionate ownership in the corporation if they wish to. These rights have been formulated to protect and safeguard shareholders.