Preemptive Rights vs Anti-Dilution

September 23, 2022 Sahil

Preemptive rights, subscription rights, and anti-dilution rights is the name given to the provisions for the investors mentioned in the shareholders’ document. In case you are wondering that the meaning of these is the same, you may be partially right. But to enlighten you, there is a difference between preemptive rights and anti-dilution rights. But before discussing the difference between preemptive and anti-dilution rights, it is important to understand the concept of preemptive rights and anti-dilution rights.

What are Preemptive Rights?

Preemptive rights are the rights available for the existing shareholders to retain the ownership stake in the company on the company’s decision to issue new shares.

Companies need funds to fulfill their capital requirements and decide to issue new shares at a price lower than the existing price. The existing shareholders are provided the option to buy the new shares of the company to maintain their ownership rights in the company. The main objective of providing this opportunity to the existing shareholders is to protect their rights in the company’s stock and ensure that the existing shareholders’ ownership interest is not diluted during additional funding.

Preemptive rights are the most common provision that is provided to the shareholders in the shareholders’ agreement. Companies provide preemptive rights to the existing shareholders to sustain their ownership rights with the company when the issuance of new shares is considered.

In this situation, the existing shareholders can avoid the situation of involuntary dilution of their ownership in the company. Down rounds are the additional issuance of shares that the company decides to issue in the market to get additional funding.

Why are Preemptive Rights Important?

Preemptive rights are important for the investors because:

It provides opportunities to the investors to protect their equity rights in the company by buying additional shares on the subsequent issue of shares.
The value of the shares held by the investors could be of great significance in case the company’s performance is good.
The existing shareholders get the opportunity to buy the shares on the subsequent down rounds.
Preemptive rights provide the current shareholders the right to refuse the purchase of new shares in case they do not opt for further purchase of the shares, giving the new investors to purchase those shares.
It protects the shareholders against the risk of the issue of new shares at a lower price than the price at which they bought the shares earlier.
It also ensures that the shareholders enjoy their rights of equity holdings, despite subsequent issues of shares in the future.
It helps the investors to build trust in the company.

Preemptive Rights Calculation Example

The concept of preemptive rights will be clear with the help of the given example:

There is a company called IKL which has initially offered 1000 shares at the rate of INR 10, in the market to acquire funding. M is a person who invests in these shares by 100 shares, thus, getting the 10% equity interest in the company. After a few months, the company again decides to issue additional 500 shares as it requires the funds. These shares are available at INR 8 per share

1. I am having the preemptive rights

In this case, M has the preemptive rights so the calculation of his equity shareholdings in the company will be as calculated below:

Total number of shares outstanding before the second issue= 1000 shares

Total number of shares owned by M = 100 shares

Equity holding of M in the company IKL = 100/1000 = 10%

Total number of shares issued in the second subsequent round by IKL company= 500 shares

Total number of shares of IKL company after the subsequent issue of shares= 1000 shares + 500 shares; hence, a total of 1500 shares

Total number of shares held by M = (100 shares @ $10 each) + (50 shares@ $8 each)

Total value of shares held by M = 1000+400= $1400

Total holdings of M in IKL company = 150/1500*100 = 10%

Thus, the total equity percentage of M in the IKL company will remain the same at 10%, and also the shareholding value will increase from $1400, and total equity holding rights will remain at 10% in case M has preemptive rights.

What are Anti-dilution Rights?

Anti-dilution is the provision that protects the existing shareholders in terms of protecting the shareholders’ rights in the company’s equity stock and protects them from dilution. Under anti-dilution, there can be two possibilities when the shares are issued at lower rates than earlier ones. They are –

If the new shares are issued at a lower price than the existing price, the value of their shares may go down as the new shares are issued at a lower price than what they had paid earlier.
If the issued shares are bought at a lower price, the existing shareholders lose their proportion of equity holdings in the company.

Thus, the existing shareholders risk getting a lower value of their shares as the average price after the following issuances will decline, providing lower earnings per share. They will also lose the share equity proportion in the equity stock because of the new shareholders. Thus, there is a need for anti-dilution provisions which protect the shareholders to dilute their shares on the issuance of new shares which is demanded by the investors to safeguard their interests.

Difference Between Preemptive Rights and Anti-dilution Rights:

Preemptive rights, anti-dilution rights, subscription rights, and first refusal rights are the terms that have been used simultaneously for the same reason, there is a smaller but significant difference between the preemptive and anti-dilution rights which is explained in the table given below:

Characteristics	Preemptive Rights	Anti-dilution
Meaning	It refers to the special rights given to the shareholders under which they are given an option to buy the additional shares offered by the company in future rounds before they are offered to the new investors.	It refers to the special rights that allow the investors to the existing investors under which they can maintain their ownership proportion in case of issue of new shares.
Fundings	Funding is done at a value higher than the shares’ existing value.	Funding is done at a price that is lower than the existing value that has been offered to the existing investors.
Protection of equity holding rights	It gives preference to the shareholders to retain their equity holding rights in the company on the next issue of shares.	It protects the rights of existing investors from the loss valuation of shares on the share issue as well as protects their rights of equity holdings in the subsequent down rounds.
Rights to refusal	The existing investors can refuse the purchase the shares that are issued in the subsequent rounds.	There are no such refusal rights as the shares are issued for both the new and existing investors.

Conclusion:

Preemptive rights help to retain the equity stock holdings of the company on a future issue of shares as the company gives the existing shares a chance to buy the new shares, before offering them to the new investors.

On the other hand, the anti-dilution right is the clause that helps the existing investors to purchase the shares at the lower price offered than the existing price. But it helps them to retain their equity stock holding rights in the company.