Preemptive rights give the incorporators of New York corporations the opportunity to protect shareholders from dilution in the event additional shares are issued in the future. Unlike most states, preemptive rights are not default rights and should be explicitly included in the certificate of incorporation if the incorporators want the rights to apply to all shareholders. In order to allow for preemptive rights for only specific shareholders, the rights can simply be included in the shareholders’ agreement. This privilege is preemptive because it is offered before those shares become available for purchase by the general public.
Preemptive Rights Protect Shareholders From Being Diluted
Typically, shareholders who invest capital into a company such as a startup, want to protect their interests in the company. This means that they want to have as much voting power in the future as they had when they initially purchased their shares of stock. Preemptive rights protect these shareholders from the potential of having their voting power diluted by offering them the opportunity to purchase shares before anyone else can do so during future issuance of shares for sale. The rights typically allow shareholders to purchase a percentage of the new issuance equal to their then current percentage ownership in the business (pro rata share).
Should Your Corporation Provide or Deny Preemptive Rights to Shareholders?
The initial incorporators of a New York corporation should discuss whether preemptive rights should be offered with their attorney. On one hand, providing this benefit encourages investment capital in your business. This could be an added incentive to potential investors in your business. On the other hand, providing these rights could make it easier for one, or more, people to increase their holdings and gain more control of the business. Preemptive rights can also be provided in only limited situations, such as major investors or specific classes of shares.
Other forms of preemptive rights can also be available to corporations such as rights of first refusal, co-sale rights and “pay-to-play” provisions.