Key Takeaways

  • Preemptive rights give existing shareholders the opportunity to buy new shares before outside investors, preventing dilution of their ownership.
  • These rights are also known as subscription rights or anti-dilution rights and are often included in shareholder agreements, LLC agreements, or corporate charters.
  • Preemptive rights are especially important in startups and closely held corporations, where early investors seek to preserve ownership and influence during future funding rounds.
  • They can benefit both shareholders (by protecting equity and influence) and companies (by encouraging continued investment from existing backers).
  • However, preemptive rights can also create administrative burdens and limit flexibility when raising capital from new investors.
  • Exemptions from preemptive rights (e.g., employee stock options, stock splits, mergers) are common to avoid unnecessary complications.
  • States vary: some automatically grant preemptive rights unless excluded, while others require explicit inclusion in governing documents.
  • LLC agreements often include tailored preemptive rights clauses, allowing members to buy pro rata shares of new issuances, with detailed provisions on notice, timelines, and exceptions.

Preemptive Rights: What are they?

Preemptive rights (also referred to as preemption rights, anti-dilution rights, subscription rights, or subscription privileges) are rights granted to certain equity holders giving them the option to purchase additional shares of a company’s stock or other securities before new investors can buy them. Preemptive rights are used to prevent new investors from reducing ("diluting") the ownership percentages of existing share or securities holders.

Preemptive rights are a common provision found in company shareholders’ and operating agreements, as well as other option, securities and merger agreements. They may also be included in the text of the subscription agreement that investors sign when purchasing stock or securities.

In addition, preemptive rights are often granted in connection with convertible preferred shares, enabling preferred shareholders to maintain their future ownership percentages when exercising options to convert their preferred shares to common shares.

Most states only consider preemptive rights valid if they are explicitly stated in a corporation’s charter. Additionally, corporation laws in some states require that preemptive rights be automatically given to shareholders of corporations formed in those states, unless specifically excluded in the corporation’s articles of incorporation.

Preemptive rights should not be confused with ”put options”, which give shareholders the right to sell the stock at a specified price.

Types of Preemptive Rights

Preemptive rights can be structured in different ways depending on the company’s governing documents and investor agreements:

  • Contractual Preemptive Rights – Explicitly written into shareholder agreements, LLC operating agreements, or investor contracts. These typically outline purchase procedures, timelines, and exemptions.
  • Statutory Preemptive Rights – Provided by state law in some jurisdictions, either automatically unless waived, or only if expressly included in the corporate charter.
  • Pro Rata Rights – A common form of preemptive right, allowing shareholders to maintain the same ownership percentage by purchasing a proportional share of new issuances.
  • Oversubscription Rights – Sometimes shareholders are allowed to purchase more than their proportional share if other shareholders decline their rights.

Why are Preemptive Rights important?

A start-up company will typically seek funding in stages (“rounds”). Investors investing money in the early stages typically demand the right (not the obligation) to maintain their ownership percentage in the company when money is raised in later rounds. This right is ensured with the granting of preemptive rights.

Without preemptive rights, the shares owned by early investors become “diluted” (i.e., the ownership percentage of early investors decreases) as new shares are issued to later investors. Here’s an illustration:

  • Your company’s initial round of equity consists of the sale of 200 shares of common stock.
  • An investor purchases 20 shares in the initial round, giving her a 10 percent ownership interest in the company. Along with the purchase, the investor is granted a preemptive right to purchase subsequent shares in order to maintain her 10 percent ownership in the company.
  • In the second round of equity, the company offers for sale an additional 1,000 shares of common stock.

With the preemptive right, the investor may purchase up to 100 shares of the newly offered 1000 shares in order to maintain her 10 percent ownership in the company. Without the preemptive right, her interest in the company will be diluted (that is, her ownership percentage will decrease) to 1.67 percent, if the entire 1,000 second round shares are sold.

How Preemptive Rights Work in Practice

When a company issues new shares, shareholders with preemptive rights typically receive:

  1. Notice of issuance – The company must notify eligible shareholders of the new offering and their right to participate.
  2. Defined purchase window – A set period (often 10–30 days) to exercise their rights.
  3. Pro rata allocation – Each shareholder may buy shares proportional to their existing ownership.
  4. Transferability – In some cases, rights can be transferred or sold to others if a shareholder does not wish to exercise them.

This process ensures shareholders have a fair chance to avoid dilution and, in some cases, to expand their influence if others decline participation.

Reasons to Consider Granting Preemptive Rights:

Here are a few of the reasons you should consider granting preemptive rights to your investors:

  • Early stage, angel, and venture capital investors typically expect, and often demand, preemptive rights as part of their investment agreements. By granting such rights to investors, it will typically be much easier and faster for your company to raise money from investors in later funding rounds. Investors with preemptive rights are already familiar with your company and are essentially “locked in” to their investment positions.
  • Potential new investors can cause time delays while performing due diligence on your company and during investment negotiations. Early investors with preemptive rights are likely to supply additional funding in later equity rounds. That means locating new investors will require less time and effort on your part, allowing you and your management team to concentrate on what is most important: operating your business.
  • A major investor with a large ownership percentage in your company will likely demand the right to appoint one or more members of his choice to the company’s board of directors, and/or to a vote on important company decisions. Therefore, the option to maintain a high ownership percentage, through preemptive rights, provides a strong incentive to early investors to participate in later equity rounds.
  • Some preemptive rights provisions include what is known as a “pay to play” requirement. Pay to play features provide for penalties (such as the conversion of preferred stock to common stock at the pre-issuance conversion price) to investors who choose not to exercise their preemptive rights in subsequent equity rounds.

Benefits to Shareholders and Companies

  • Investor Confidence – Existing shareholders know their investment can remain stable over time.
  • Long-Term Support – Encourages early investors to reinvest in later rounds, reducing reliance on new investors.
  • Valuation Protection – Protects against dilution during down rounds where new shares are issued at lower valuations.
  • Alignment of Interests – Strengthens trust between founders and early investors by ensuring fairness in future financing.

Reasons to Consider Not Granting Preemptive Rights:

The following are a few reasons to consider not granting preemptive rights:

  • By opting to not grant preemptive rights, your company will have more flexibility in locating new investors and negotiating investment terms with them on an individual basis.
  • Investors who accumulate a significant stake in your company are likely to demand additional rights and greater involvement in the company’s management. By denying preemptive rights, you may be able to maintain management control of your company by limiting size of an individual investor’s company ownership percentage.
  • Preemptive rights can create an unwanted administrative burden when you are trying to raise new money. For example, it becomes more difficult to promise a new investor that she will be able to acquire a certain percentage of the company if you are uncertain as to whether or not early investors intend to exercise their preemptive rights.
  • Existing shareholders with preemptive rights are likely to demand detailed information from the company regarding subsequent equity rounds in order to decide whether or not to exercise their preemptive rights. This will likely result in unwanted time delays in raising additional funds. One possible solution to this problem is to grant preemptive rights only to your significant shareholders/equity holders (i.e., those owning more than a threshold percentage of your company’s equity).

Challenges with Preemptive Rights

While protective for investors, preemptive rights may complicate company growth:

  • Slower Capital Raising – The requirement to notify shareholders and wait for responses can delay financing.
  • Reduced Flexibility – Companies may find it harder to negotiate with new investors who expect guaranteed allocations.
  • Concentration of Power – Major investors exercising rights repeatedly can consolidate influence, which may discourage new capital.
  • Legal Complexity – Especially in multi-class share structures or LLCs, balancing who receives rights can be administratively difficult.

Common Mistakes Associated with Preemptive Rights

Companies should bear in mind that certain issuances of new securities should be exempted from preemptive rights. Examples of customary exemptions include:

  • Shareholders converting preferred stock to common stock under the existing terms of preferred stock ownership.
  • Shares of stock or equity units awarded to valued employees as part of their compensation.
  • Shares of stock or equity units designated in employee equity plans.
  • Stock shares or equity units associated with company restructuring, such as an equity split (increasing the number of authorized shares/units) or equity combination (reducing the number of authorized shares/units).

Typical Exemptions to Preemptive Rights

To avoid unnecessary burdens, companies often exempt certain issuances from preemptive rights, such as:

  • Employee compensation plans – Stock options, restricted stock, or equity incentives.
  • Mergers or reorganizations – Shares issued in connection with strategic transactions.
  • Small-scale issuances – De minimis amounts of new stock that don’t materially affect ownership percentages.
  • Preferred stock conversions – Already agreed upon under prior financing terms.

Clearly stating these exemptions in governing documents helps prevent disputes and ensures smoother capital-raising processes.

Frequently Asked Questions

1. Are preemptive rights automatically granted to all shareholders?

Not always. Some states automatically grant them unless excluded, while others require explicit inclusion in the company’s charter or operating agreement.

2. Can preemptive rights be waived?

Yes. Shareholders can voluntarily waive their preemptive rights, either generally in an agreement or on a case-by-case basis during a financing round.

3. How do preemptive rights affect startups differently than large corporations?

Startups often use preemptive rights to reassure early investors, while larger public companies rarely include them because of the complexity and scale of issuing new shares.

4. Do LLCs use preemptive rights?

Yes. LLC agreements frequently include tailored preemptive rights, granting members the option to purchase future membership interests in proportion to their ownership.

5. What happens if shareholders decline to exercise their preemptive rights?

If some shareholders do not exercise their rights, other shareholders may be allowed to purchase the remaining shares, or the company may offer them to outside investors.

Support for Preemptive Rights

If you feel you need help in drafting or negotiating a preemptive rights provision, consider posting for that help on UpCounsel's marketplace. UpCounsel screens out 95% of lawyers to provide only the best lawyers from top law schools, like Harvard or Yale. UpCounsel lawyers have an average of 14 years of experience each providing legal services to such companies as Menlo Ventures, Airbnb, and Google.