What are pre-emptive rights in shareholders agreements?
How pre-emptive rights protect the interests of shareholders within a company
Pre-emptive rights in shareholders agreements are an important aspect of corporate governance and are designed to protect the interests of existing shareholders within a company.
Pre-emptive rights ensure fairness in the issuance of new shares by allowing existing shareholders to acquire shares prior to those shares being offered to third parties. This means that existing shareholders have the opportunity to maintain their proportionate ownership in the company, even if new shares are issued.
Common types of pre-emptive rights are:
Right of first refusal whereby a shareholder who wants to sell their shares must first offer those shares to other shareholders in proportion to their current shareholding. The existing shareholder can only offer the shares to a third-party buyer if the existing shareholders choose not to buy them.
Right of last refusal whereby an exiting shareholder who has found a third-party buyer is required to give other shareholders an opportunity to match the price before it can sell those shares to the third party.
Pre-emptive rights can operate both in respect of issued shares held by current shareholders, as well as new shares issued by the company.
What should be included in a pre-emptive rights clause?
Well-crafted pre-emptive rights clauses will include key elements such as:
A clear definition of the rights being granted to existing shareholders and the circumstances under which existing shareholders are entitled to purchase newly issued shares.
Eligibility requirements for existing shareholders who wish to exercise their pre-emptive rights.
An outline of the process by which existing shareholdings can exercise their rights, including any deadlines and information that must be provided in order to participate.
Specify the priority of pre-emptive rights. For example, shareholders who have held shares in the company for the longest period of time might have priority in purchasing newly issued shares.
Provisions for dispute resolution mechanisms to help avoid and/or resolve any disputes between existing shareholders and new investors which may arise.
Legal considerations
Some of the key legal considerations relevant to the exercise and protection of pre-emptive rights in shareholders agreements are listed below:
Restrictions on the transfer of shares
The Corporations Act 2001 (the Act) imposes restrictions on the transfer of shares within a company. These restrictions can impact the exercise of pre-emptive rights in shareholders agreements, particularly in circumstances where existing shareholders are required to purchase newly issued shares. In such cases, it is important to ensure that the transfer of shares complies with the restrictions under the Act.
Valuation by newly issued shares
When newly issued shares are offered for sale, it is important to determine their value. This can be a complex process, sometimes requiring the appointment of an independent valuer to determine the market value of the shares. In such circumstances, the appointment of a valuer should be contemplated by and provided for in the shareholders agreement.
Disclosure requirements
In Australia, unless falling within an exemption, there are strict disclosure requirements which must be adhered to when issuing new shares. Companies are required to disclose to potential investors information about the company such as its financial performance and future prospects. Failure to do so can result in penalties, including fines and legal action. Thus, it is essential that companies are mindful of these requirements when enlivening any pre-emptive rights.
How can we help?
Pre-emptive rights require careful consideration and can easily be misunderstood or poorly managed. It is essential that companies ensure that pre-emptive rights in shareholders agreements are appropriately drafted and regularly reviewed, taking into consideration the intended purpose of the provisions and the specific circumstances of the company.
Merton Lawyers are experts in corporate governance and preparing bespoke shareholders agreements. To discuss how we can assist you, please contact our corporate team to arrange an initial consultation.
