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Pre-emption rights (sometimes called rights of first refusal) are contractual provisions that grant existing shareholders the right to maintain their proportional ownership by giving them priority to purchase new shares before they can be offered to third parties, preventing dilution of their ownership stake and control.
Pre-emption rights can be found in:
Under Section 561 of the Companies Act 2006, UK companies have statutory pre-emption rights that require new equity securities to be offered first to existing shareholders in proportion to their current holdings. However, private companies often modify or disapply these statutory rights in their articles of association to create bespoke arrangements that better suit their specific circumstances.
While pre-emption rights are commonly associated with share transfers, they have several other important applications:
New Share Issues - protects against dilution when a company issues new shares to raise capital. Existing shareholders have the right to subscribe for new shares in proportion to their existing shareholding before shares can be offered to third parties.
Asset Sales - for example, when a company considers selling valuable real estate or intellectual property, shareholders may negotiate pre-emption rights over these assets to ensure they have the first opportunity to acquire them if sold.
Joint Ventures - pre-emption rights can apply to the transfer of 1 of the venturers interest, ensuring the remaining party or parties maintain control over who joins the venture.
Commercial Contracts - such as distribution agreements, where a supplier may want the right to re-acquire distribution rights before they can be transferred to a third party.
Pre-emption rights are rarely absolute. Their scope and application are typically subject to extensive negotiation:
1. Valuation Mechanisms
How shares or assets are valued is critical. Options include:
Fair market value as determined by independent valuers
Formula-based pricing (e.g., multiple of EBITDA)
Matching third-party offers
Predetermined fixed prices or discounts
Example: In a private equity investment, investors might negotiate pre-emption rights with a valuation mechanism based on the most recent funding round valuation, while founders might push for independent valuation to capture business growth since the last round.
2. Permitted Transfers
Most agreements include specific exemptions where pre-emption rights do not apply:
Transfers to family members for estate planning
Transfers to affiliated entities or within a corporate group
Transfers to trusts for the benefit of the transferring shareholder
Employee share schemes
Example: A family-owned business might permit transfers between family members without triggering pre-emption rights while requiring pre-emption rights for any external transfers.
3. Time Limitations
Pre-emption processes cannot drag on indefinitely:
Notice periods for expressing interest (typically 14-30 days)
Periods for completing transactions (often 30-60 days)
Fall-away provisions if shareholders do not exercise their rights
Example: A tech startup's shareholders' agreement might specify that existing investors have 21 days to indicate interest in purchasing shares offered by a departing founder, with completion required within 45 days thereafter.
4. Partial Exercise
Negotiations often address what happens when pre-emption rights are only partially exercised:
Pro-rata allocation of remaining shares among interested shareholders
Waterfall provisions determining priority among different classes of shareholders
Default mechanisms allowing external sale of unsubscribed portions
Example: In a venture capital-backed company, Series A investors might have first priority to exercise pre-emption rights, with any remaining shares offered to seed investors, before founders can finally offer leftovers to new investors.
5. Drag-Along and Tag-Along Interaction
Pre-emption rights frequently interact with drag-along rights (allowing majority shareholders to force minorities to join in a sale) and tag-along rights (allowing minorities to join in a sale on the same terms as the majority):
The pre-emption process may need to complete before drag-along rights can be exercised
Tag-along rights might be triggered if pre-emption rights are waived
Specific thresholds may determine which rights take precedence
Example: If a majority shareholder holding 60% wishes to sell, minority shareholders might first have pre-emption rights to purchase these shares. Only if they decline would the majority shareholder be able to exercise drag-along rights to force the sale of 100% of the company.
Several practical considerations limit the effectiveness of pre-emption rights:
Financial Capacity - pre-emption rights are only valuable if shareholders have the financial capacity to exercise them. Without adequate resources, these rights become theoretical rather than practical protections.
Timing Constraints - the pre-emption process takes time, which can be problematic in urgent situations such as emergency funding requirements or time-sensitive acquisition opportunities.
Strategic Investors - sometimes companies need to bring in strategic investors who can add specific value beyond capital. Pre-emption rights can complicate these arrangements unless carefully structured.
When structuring pre-emption provisions:
Be specific about valuation methodology – Ambiguity leads to disputes
Define clear timelines – Precise deadlines keep processes moving
Consider including accelerated procedures for emergency situations
Address partially exercised rights explicitly – What happens if only some shareholders participate?
Harmonize with other transfer provisions like drag-along and tag-along rights
Review regularly – As companies grow, pre-emption structures may need updating
Pre-emption rights should balance the interests of existing shareholders against the company's need for flexibility and growth. Contact our experienced and specialist team for legal advice, drafting, review or negotiation of pre-emption rights and other shareholder rights, rules or corporate legal matters.
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Partner - Commercial law and Data issues
Phil specialises in assisting SMEs and owner-managed businesses with their non-contentious commercial contracts and data protection needs. He qualified as a Solicitor in 2002 and has worked in Legal 500 ranked firms during his career.
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