Pre-emption rights give existing shareholders the first chance to buy shares before they go to anyone else. In the UK there are two kinds. Pre-emption rights on allotment cover new shares the company issues and come from the Companies Act 2006. Pre-emption rights on transfer cover existing shares that a shareholder wants to sell, and they only exist if the company’s articles or shareholders’ agreement create them.
Both kinds protect the size of each shareholder’s stake. When new shares go to someone else without being offered to the existing shareholders first, their percentage falls whether they agreed to it or not. That’s why an investor coming into a round usually wants pre-emption rights disapplied for the shares they’re buying, and kept for later share issues.
I’ve raised £250m+ for my own companies and funded more than 750 businesses with over £1bn, so I’ve seen share issues as a founder, as an investor and as a lender.
What Pre-Emption Rights Are
Under section 561 of the Companies Act 2006, Part 17 Ch.3, a company can’t allot equity securities to anyone unless it has first offered them to every holder of ordinary shares, in proportion to what each already holds, on the same or better terms.
Equity securities are ordinary shares and rights to subscribe for or convert into them, so options and convertible loan notes are caught when they’re granted. Any share counts as an ordinary share here unless its rights to dividends and capital are capped at a set amount, so many preference shares count too.
The offer has to state how long shareholders have to accept, and that period must be at least 14 days. The company can’t allot the shares to anyone else until the period has ended or every shareholder has said yes or no.
If the company doesn’t follow the rules, the company and every officer who knowingly allowed it have to compensate any shareholder who should have had an offer, with claims brought within 2 years of the return of allotment being filed at Companies House.
Some share issues fall outside the statutory right altogether:
- bonus shares
- shares paid for wholly or partly with something other than cash, such as shares issued to buy another company
- shares issued under an employees’ share scheme, such as shares from employee options
- the shares the founders take when the company is formed
Statutory Rights vs the Articles vs the Shareholders’ Agreement
Pre-emption rights can come from three places, and which one applies decides what has to happen before shares are issued.
| Source | What it covers | How it’s changed or switched off |
|---|---|---|
| Companies Act 2006, section 561 | New ordinary shares, and rights to them, issued for cash | Excluded by a private company’s articles, or disapplied by the articles or a special resolution |
| Articles of association | Whatever the articles say: new shares, transfers or both | A special resolution to change the articles |
| Shareholders’ agreement | Whatever the parties agree | By the parties, as the agreement allows |
The statutory right applies unless something displaces it. The model articles for private companies, which many UK companies adopted on incorporation and never changed, say nothing about pre-emption on new shares, so the Companies Act rule applies to those companies in full. They don’t create pre-emption on transfer either. They only let the directors refuse to register a transfer.
A private company can exclude section 561 in its articles, completely or for certain kinds of share issue. Companies that have raised from investors often do this and put their own pre-emption clause in the articles instead. Pre-emption terms in a shareholders’ agreement bind the people who signed it, as a contract between them.
Pre-Emption on Allotment vs Pre-Emption on Transfer
| On allotment | On transfer | |
|---|---|---|
| What it covers | New shares issued by the company | Existing shares sold by a shareholder |
| Where the money goes | Into the company | To the selling shareholder |
| Where the right comes from | Companies Act 2006, unless excluded, or the articles | The articles or shareholders’ agreement only |
| Price | The price the company is issuing at | An agreed price, the price a buyer has offered, or fair value set by a valuer, depending on the articles |
| What it protects | Each shareholder’s percentage | Who can become a shareholder |
Pre-Emption Rights on Allotment
Say a company has 100,000 shares. The founder holds 70,000 and an angel investor holds 30,000. The company issues 25,000 new shares at £4 each to raise £100,000.
With pre-emption, the founder is offered 17,500 shares for £70,000 and the angel is offered 7,500 shares for £30,000. If both take them up, the founder still owns 70% and the angel 30%. If pre-emption is disapplied and a new investor takes all 25,000 shares, the new investor owns 20%, the founder’s stake falls to 56% and the angel’s to 24%.
| Shareholder | Before | With pre-emption, all taken up | Pre-emption disapplied |
|---|---|---|---|
| Founder | 70,000 shares (70%) | 87,500 shares (70%) | 70,000 shares (56%) |
| Angel | 30,000 shares (30%) | 37,500 shares (30%) | 30,000 shares (24%) |
| New investor | None | None | 25,000 shares (20%) |
| Total | 100,000 | 125,000 | 125,000 |
That fall in percentage is equity dilution. On its own it isn’t a loss, because each shareholder now owns part of a company with £100,000 more in it. Pre-emption means it only happens to a shareholder who has had the chance to put money in and keep their percentage.
Pre-Emption Rights on Transfer
A transfer pre-emption clause says that a shareholder who wants to sell has to offer their shares to the other shareholders first. Some clauses work as a right of first offer, where the seller offers the shares internally before looking for a buyer. Others work as a right of first refusal, where the seller finds a buyer and the other shareholders can then match the price.
The clause usually sets out things like how the price is decided, with an independent valuer if the parties can’t agree, how long the other shareholders have to accept, and permitted transfers that skip the process, such as moving shares to a family trust.
Without a clause like this, a shareholder in a company on the model articles can agree to sell to anyone, and the only control is the directors’ power to refuse to register the transfer. Transfer pre-emption means shares can’t end up with a competitor without the other shareholders first having the chance to buy them. It often sits alongside drag-along and tag-along rights and leaver provisions.
Disapplying Pre-Emption Rights
Disapplying pre-emption rights means switching off the statutory offer for a share issue, or giving the directors power to issue shares without it. The Companies Act gives three routes:
- A private company with one class of shares. Under section 569, the articles or a special resolution can give the directors power to allot shares of that class as if section 561 didn’t apply, or applied with changes they decide.
- Directors with general authority to allot. Under section 570, where the directors have general authority to allot shares, the articles or a special resolution can let them use it without pre-emption. The power ends when that authority ends or is revoked.
- One specific share issue. Under section 571, a special resolution can disapply pre-emption for a named allotment. The directors have to recommend it and send shareholders a written statement of their reasons, the amount the company will receive for the shares and their justification for that amount. Knowingly or recklessly putting anything misleading, false or deceptive in that statement is a criminal offence.
A special resolution needs at least 75% of the votes cast, and a copy goes to Companies House within 15 days of being passed.
The directors also need authority to issue the shares. In a private company with one class of shares they have it unless the articles say otherwise. In any other company they need authority under section 551, given by the articles or an ordinary resolution, for a maximum number of shares and no more than 5 years.
With a small number of shareholders there’s a simpler way. The company makes the offer and every shareholder declines it in writing. Section 561 lets the company allot once every offer has been accepted or refused, so it doesn’t have to wait for the 14 days to run out.
Why Investors Ask for It
An investor coming into a round wants the new shares issued to them. If the company has to offer those shares to the existing shareholders first, the existing shareholders could take some or all of them. So the term sheet usually makes it a condition of the deal that pre-emption is disapplied or waived for that round.
The same investor will then usually want pre-emption rights for themselves on later share issues, so their stake can’t be diluted without the chance to invest. These are often called pro rata rights. They normally come with exceptions for things like the employee option pool, shares issued when convertible loan notes convert, and shares issued to buy another business.
What Founders Can Negotiate
The pre-emption terms are written into the articles and the shareholders’ agreement when a round completes, and they cover things like:
- Who gets the right. Some investor articles give pre-emption on new shares only to holders of the investor’s share class. The founder’s ordinary shares can be included in the same right.
- The exceptions. Every exception is a share issue the founder can’t take part in. The option pool comes out of the existing shareholders, so its size and what counts as a permitted issue both matter.
- Shares nobody takes. The articles decide whether shares one shareholder turns down go to the shareholders who took theirs up, or to outsiders.
- The vote. A special resolution needs 75% of the votes cast, so a shareholder with more than 25% of the votes can stop a disapplication resolution from passing.
- Transfer terms. How the price is set when a shareholder sells, and which transfers are allowed without going through the process.
How to Issue New Shares When Pre-Emption Applies
- Read the articles and shareholders’ agreement. Check for pre-emption clauses, investor consent rights and the share classes in issue.
- Confirm the directors’ authority to allot. Under section 550 or section 551.
- Decide how pre-emption is dealt with. An offer to existing shareholders, written refusals from all of them, or a disapplication resolution.
- Make the offer. It goes in hard copy or electronic form, pro rata to holdings at a record date within the 28 days before the offer, and stays open for at least 14 days.
- Allot the shares. Update the register of members and issue share certificates.
- File at Companies House. The return of allotment, form SH01, is due within 1 month of the allotment, and any special resolution within 15 days of being passed.
FAQs
Do pre-emption rights apply to private companies?
Yes, section 561 applies to private and public companies. A private company can exclude it in its articles, and many that have raised from investors replace it with their own pre-emption clause.
Do pre-emption rights apply when shares are transferred?
Only if the articles or a shareholders’ agreement say so. The Companies Act gives no pre-emption right on transfer, and the model articles for private companies don’t add one.
What happens if a company issues shares in breach of pre-emption rights?
The company and any officer who knowingly allowed it can be made to compensate the shareholders who should have been offered shares. The claim has to be brought within 2 years of the return of allotment being filed.
Do other countries have pre-emption rights?
Yes, but the rules differ. In Delaware, where many US startups are incorporated, shareholders have no pre-emptive rights unless the certificate of incorporation grants them. In Australia, the Corporations Act 2001 gives shareholders in a proprietary company pre-emption on new shares of their class, as a replaceable rule that the company’s constitution can change, and a general meeting can approve a particular issue without it.
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This explains how pre-emption rights generally work for UK companies. It isn’t legal advice, and a solicitor should check the company’s articles and agreements before shares are issued or transferred.
