Preemptive Rights Agreement
A Preemptive Rights Agreement is a contractual provision that grants existing shareholders the right to purchase additional shares of stock before the company offers them to outside investors. This right is designed to protect shareholders from dilution of their ownership interest in the company when new shares are issued.
The agreement typically stipulates the terms under which shareholders can exercise their preemptive rights, including the price per share and the timeframe in which they must act. For instance, if a company decides to issue new shares, it must first offer those shares to existing shareholders, allowing them to maintain their proportional ownership. If they choose not to exercise their rights, those shares can then be offered to new investors.
For example, consider a company with 1,000 shares outstanding and an existing shareholder owning 100 shares, representing 10% ownership. If the company decides to issue an additional 500 shares, the shareholder has the right to purchase 10% of those new shares (50 shares) to maintain their ownership percentage. If the shareholder declines, their ownership percentage will decrease as new shareholders acquire the newly issued shares.
Overall, a Preemptive Rights Agreement is an important mechanism for existing shareholders to safeguard their investment and maintain control over their stake in the company.
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