Preemptive Rights

When purchasing stock in a corporation an investor will typically ask for a representation in the purchase agreement setting forth the percentage of stock in the corporation the investor will own immediately following the closing.  For instance, if an investor purchases 100,000 shares of stock for $100,000 she will want to know that the 100,000 shares represents say 5% of the stock of the corporation. Thus, if the corporation is later sold for $5,000,000 then, provided no further shares have been issued, the investor knows she will receive $250,000 of the sales proceeds.   However it is a rare corporation that does not subsequently issue stock after a capital raise, as the corporation will typically need to sell additional shares of stock to fund operations. It is for this reason that investors often ask for preemptive rights with respect to subsequent capital raises. Pursuant to preemptive rights, if a corporation sells stock to raise capital the existing shareholders will have the right to purchase their pro-rata share of stock being sold on the same terms being offered to new investors. Thus, a shareholder who owns 5% of the stock of a corporation would have the right to purchase 5% (or such lesser amount as the shareholder may elect) of the shares being offered for sale.  Please note, preemptive rights will typically not apply to all issuances of stock.  For instance, there are almost always carve outs with respect to stock issued pursuant to the exercise of stock options, in connection with mergers or in furtherance of a strategic partnership. 

If you would like to know more about preemptive or other shareholder rights please contact Stephen Goldstein at sgoldstein@sgoldlaw.com, or at (212) 586-5555.