Preemptive right

A preemptive right is the right of existing shareholders to maintain their proportion of ownership of a company; they do so by acquiring their proportional share of any additional stock issuances. This right ensures that a shareholder's ownership interest is not diluted through the issuance of more shares. Preemptive rights are not necessarily granted to all shareholders. Usually, this right is granted to specific shareholders, typically those who were early-round investors.

For example, a shareholder has 1,000 shares in a company, which currently has 5,000 shares outstanding. At this point, the shareholder owns 20% of the business. The company wants to sell another 5,000 shares in order to raise funds. If the shareholder wants to maintain the same proportional ownership of the business, it must buy 1,000 of these additional shares.

The existence of a preemptive right does not require an existing shareholder to purchase additional shares. The shareholder can choose not to exercise the right, in which case shares are sold to other parties and the existing shareholder's proportion of ownership in the business declines.