Pre-emption right
A pre-emption right, right of pre-emption, or first option to buy is a contractual right to acquire certain property newly coming into existence before it can be offered to any other person or entity. It comes from the Latin verb emo, emere, emi, emptum, to buy or purchase, plus the inseparable preposition pre, before. A right to acquire existing property in preference to any other person is usually referred to as a right of first refusal.
Company shares
In practice, the most common form of pre-emption right is the right of existing shareholders to acquire new shares issued by a company in a rights issue, usually a public offering.Legal framework and share issuance
The legal foundation for pre-emption rights varies by jurisdiction but generally ensures that shareholders can maintain a proportional stake in the company's authorized capital.European Union and Germany: Under Section 186 of the German AktG, shareholders are entitled to a portion of new shares corresponding to their existing holding in the share capital. This entitlement extends to hybrid instruments such as convertible bonds, options, and profit-participation certificates under Section 221 AktG.United Kingdom: Statutory pre-emption rights are governed by Section 561 of the Companies Act 2006, which mandates that any "equity securities" must first be offered to existing shareholders on the same or more favorable terms.United States: Unlike the EU, pre-emption rights in the US are typically not a statutory default for public corporations but are established through a company's charter or bylaws. Where they exist, they function as a contractual protection against dilution.When a company issues new shares, it must define the subscription terms. These terms include the subscription ratio, the subscription price, the dividend entitlement, and the subscription period. The subscription price is typically set below the current market price of the "old" shares to mitigate issuance risk and encourage participation.
Until the young shares reach dividend parity with old shares, they may trade at different prices on the stock exchange. Dividend entitlement for young shares often begins only with the start of the new fiscal year. The value of the subscription right is mathematically determined by the interplay of the current share price, the subscription price, and the dividend differential.
Background and rationale
The reasons for granting pre-emption rights are multifaceted. In many European jurisdictions, such as Germany, granting these rights is mandatory for capital increases exceeding 10% unless extraordinary circumstances apply. The primary purpose is to protect existing shareholders from the dilution effect, which reduces their effective stake in the company. This protection applies both to the influence exerted through voting rights associated with common stock and to the relative share of dividends for both common and preferred stock.Rights issue procedure
In the European Union and the United Kingdom, the procedure for a capital increase with pre-emptive rights follows strict statutory timelines. Shareholders must be offered the new shares for a period of at least 14 days. If no stock exchange holidays fall within this period, this typically equates to ten trading days. The offer must specify the exact subscription price or the formula used to determine it; in the latter case, the final price must be announced at least three days before the offer period expires.Mathematical Evaluation (Subscription Formulas)
The valuation of these rights is determined by comparing the share capital before and after the increase.Subscription Ratio :- '''Theoretical Value of the Right :'''