What it is and how to calculate it.
Preemption gives your existing shareholders a right to buy more shares, whenever the company issues more shares, to maintain their existing shareholder % in the company.
In general existing shareholders will have a preemption right, so when you do a new funding round, unless they've signed an agreement to waive that right, you'll need to offer them a right of preemption.
So, if you’re doing a new funding round and your existing shareholders have a preemption right, you'll now need to work out what investment each will need to make if they want to exercise their preemption right.
Welcome to the wonderful world of preemption calculations!
Firstly, work out how much equity you’re going to be giving away in your new round.
If you’re doing your round on SeedLegals, we’ll automatically work that out for you.
calculate the price per share of the shares you’re issuing in your new round
decide how much you want to raise in total from new investors
then, work out the number of shares that equates to
then, work out what % new equity you’ll be giving away in your new round
which will be New Shares / (Existing Shares + New Shares)
Let’s say you’re giving away 10% equity in your new round.
This means your existing shareholders will need to top up their existing shares by this much if they want to maintain their equity percentage after the new round.
So, each existing shareholder who wants to exercise their preemption right will need to buy:
N / (100-N) times their existing number of shares,
where N is the % equity dilution in the new round
e.g. if you’re giving away 10% equity in the new round, an existing shareholder would need to buy 11.11% times their existing number of shares to stay at the same % equity that they had before the round.
Then, the next thing is to calculate how much in £ each investor would need to pay to exercise their preemption right.
Your first guess might be that each existing investor would need to top up their last investment by, using the example above, 11.11% of the amount they previously invested. But, that’s wrong because the price per share is now different (hopefully much higher) than the last round.
So, multiply the new number of shares that each investor needs to buy, by the price per share in the new round -> that’s the amount they’ll need to invest now.
Great, so we’ve calculated the preemption amounts for each existing shareholder, nice.
But wait… there’s a problem…
If any shareholder decides to exercise their preemption right it will change the total amount you’re raising, which then changes the preemption amount for themselves and everyone else.
So you can only accurately calculate the preemption amounts for each shareholder once all shareholders have indicated whether they want to take up their preemption right or not.
At that point it becomes an iterative formula to:
add together all the preempting investors
calculate the total preemption amount for them
add that amount to the investment in the new round
work out the new % equity that you would be giving away in the round, now including the preemption investments
redo the preemption calculations based on new total investment amount (the preemption amount will have increased)
redo steps 1-6 a few times, until you have the desired level of accuracy in the calculations (e.g. if your preempting shareholders would add, say, 5% additional investment in the new round then your calculations would be about 95% accurate after the 1st pass, 99.7%+ accurate after the 2nd pass, etc.
Given the amount of work to calculate the preemption numbers we suggest the following approach:
Create a Preemption Letter (this is automatically created as part of your round on SeedLegals)
Send it to each existing shareholder that has a preemption right, giving them 10 business days (that’s the default) to reply saying they want to exercise their preemption right.
Wait 10 days (or less, if everyone has responded sooner)
Add up the number of shares of all the shareholders who replied saying yes.
Calculate the preemption amounts, per the steps above.
If any shareholders get back to you asking what their preemption amount would be, before everyone else has responded, you can run an indicative calculation as per the steps above, based simply on the amount you’re raising in the new round. BUT let them know that this is just an indicative amount, plus/minus a few percent, because the precise preemption amounts can only be calculated once all the existing shareholders have indicated whether they’ll preempt or not.