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Preemptive Rights (Definition,Types) | Example | Importance - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to channel of
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clicking the bell icon today we have a
topic with us is called pre-emptive
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rights now what exactly this is all
about we'll try and get this topic in a
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very detailed format let's begin first
what is or what are pre-emptive rights
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this is what we need to understand so
pre-emptive rights refers to the right
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available to the shareholders they have
to maintain the ownership stake by
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giving them they know the chance to buy
proportionate interest in any additional
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issuance of the common stock in future
so this are the rights that have been
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granted to certain or equity
shareholders under which they are given
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an option to purchase additional shares
of the company stock before the same is
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offered to any new investor these are
the rights available to the existing
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shareholders to maintain their
proportion of the ownership to propose
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to maintain the ownership of a company
now this is done to the proportion of
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the ownership in the manor of the
company it is maintained by acquiring
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the proportional shares in the
additional stock issuance of the company
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so thereby no they ensure that the
shareholders ownership interest does not
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get diluted even if company's issues
more shares now in short the pre-emptive
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rights are important to shareholders
because it allows the existing
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shareholders of a company to avoid any
in 1 3 dilution of their ownership stake
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by giving them a chance to buy you know
proportion interest in the future
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issuance of the common stock now this
pre-emptive rights are also known as you
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know subscription it is also known as
the subscription rights you know or
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entitle you to its entitle you to rights
or subscription privilege so this is
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commonly provisions are found in the
shareholders
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agreement it is found in shareholders
agreement and the pre-emptive rights are
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important to shoulder because you know
it is used to prevent the new investors
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from reducing the existing ownership
percentage of the existing shoulder so
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it is pertinent to note the here that
you know having those rights does not
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require an existing shareholders to purchase the additional shares the additional
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shares you know compulsorily though the
so this the shareholders can choose not
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to make use the rights in such cases and
the shares are sold to new investors an
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existing shoulder proportion to the
ownership in the business now second why
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are this pre-emptive rights important
this is a very important topic see the
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investing in the initial stage of the
company is risky proportion all these
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stage investors would like to ensure
that in other risk they have taken
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should be rewarded with the due returns
once the company becomes successful
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these rights are important to
shareholders you know because it grants
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the shareholders and opportunity but not an obligation to keep their initial
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ownership initial ownership that has
returned even when the company goes for
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additional round of equity issuance by
giving them the opportunity of the right
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of the first refusal that is only when
the existing shoulders are not
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subscribing to the fresh issue in the
proportion to their existing ownership
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the company can bring in new investors
and result on the proportion declines in
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their ownership now the another reason
these rights are important to the
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shareholders because you know it
protects the investors from the risk of
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new shares being issued at a price that
is a completely lower then the price the
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price is lower than the price that is
paid by the previous investors so this
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is particularly more relevant in case of
the convertible preference shares so
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let's take one example so that you know
you you surely get some really good
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insight regarding this particular thing
we'll take example number one the
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pre-emptive rights example number one
see let's say there is a company called
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Rent International they have issued a
convertible preference stock that is PS
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CPF CPS 2p let's say is a person at at
the rate of
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$15 per share $15 or
sure okay fine
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now this is convertible at the end of
the 2 years of time span that's a
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locking period it means P can convert
the preference talk into common stock by
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paying $15 as you can see each ray
international after a specified period
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that is 2 years in this case so array
international decided to go public and
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issued equity shares closely around $12
per share to general public so now P
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converts his preferred stock into equity
shares either at a 15 against 12 or
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share that is offered to general public
so this will clearly devalue the
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incentive to convert however if the
rights states that if ray international
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issue shares at a price that is lower in
the previous financing down the
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preferential does in this case P gets
more shares of common stock when he or
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she converts so in such a scenario this
rights protected the interest of P from
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the risk of new shares being issued at a
price that is lower than the previous
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issue now also these rights are very
important to shareholders because you
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know it incentivizes the company to
perform well so that they can issue
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stocks at close the higher valuation and
whenever they need need arises so at
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that time they can issue that we'll take
an example of it you understand let's
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and let's understand more with the help
of the more example let's say there's a
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company called Ananya or Corp and that
have issued 1000 shares of stock
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outstanding so we here k now over here k
owns a let's say a 100 shares of
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Ananya and thereby effectively holding
10% of the entire corporations thereby
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it is effectively holding 10% of the
entire corporation okay the board of
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direction of Ananya corporation decided
to sell another 1000 shares of the
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corporation for 20 each at the rate of
20 each now if K is not
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provided with the pre-emptive right this
would dilute his ownership of the shares
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the number of shares outstanding before
the issue was 1000 shares the
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number of shares owned by K okay that is
100 shares the K holding in Ananya
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corporation K in Ananya corporation is
100 divided by 1,000 alt H and P that's
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percent okay
and the number of shares of the fresh
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issue of 1000 shares that is 1000
initially plus 1,000 additional shares
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issued so the number of shares owned by
ki is 100 and K holding in corporation
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will be 100 shares divided by 2,000 so
this has to be yeah so that is 5%
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holding now so k ho so k holding
in a Ananya corporation declined from
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10 to 5 percent okay in case of the
fresh who shown to the right and if this
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rights are not available let's assume
that pre-emptive rights are available to
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K and he exercises those rights by
subscribing to the fresh issue in
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proportion to the existing ownership
then the number of the shares
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outstanding before the issue was 1000 number of shares owned by K 100
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K holding in Anya is 10% number
of the fresh issue is 2000
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shares and the number of the additional
shares that is subscribed by K is one
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100 shares at the rate into 20 so
that comes to 2000 right so it
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will be 100 shares plus 100
shares that is 200 divided by
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2000 that comes down to 10%
if he subscribes right so this is how
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the whole example works now I will take
you to some of the types of the
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preemptive rights what are the types
first is by weighted average now see
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under the existing shareholders is
provided with the right to purchase the
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shares at a price that takes into
consideration the change in the old
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price and the new offer price second
it's called ratchet tender this you know
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existing shoulders is provided with
right to buy the shares at a new lower
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price now I'll take you quickly on the
advantage part of the pre-emptive right
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so it becomes easy for the business to
raise funds for easy fund raising from
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the existing early stage investor and
venture capitalists as they are already
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familiar with the company and it avoids
the cost of due diligence time delays
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and excessive negotiations with a new
investor so if existing investors are
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providing additional funding it saves
the management in in searching new
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investors and the disadvantage is that
it it avoids the problem of
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concentrations of ownership in the few
early stage investors only and allows
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the business to exercise more control
over the business and limits the size of
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the individual investors ownership in
business so it helps the company to
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negotiate better when the new investors
and the command higher valuation for the
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business than the existing investor so
many new investors intend to hold
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significant ownership in the business
and want to promise new investor that he
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or she will be able to acquire a certain
percentage in case where the right is
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being provided to early stage investors
as businesses uncertain and as to
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whether or not all investors
intend to exercise this pre-emptive
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rights so that's it for this particular
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