Preemption gives your existing shareholders a right to buy more shares to avoid dilution (maintain the size of their stake in the company), whenever the company issues more shares.
As per section 561 of the Companies Act, existing shareholders will have a preemption right, so when you do a new funding round, unless they've signed a shareholders resolution to disapply the right of preemption, or you’ve opted out of preemption in your current Articles of Association, you'll need to offer existing shareholders the ability to take up their right of preemption before proceeding taking in any new funds.
Read on to find out how to offer the right of preemption, how to calculate it, and how we’ve made it easier for you to figure out how many shares to give to shareholders who want to uptake their right of preemption.
The legal way of doing preemption vs. what happens in practice
Legally, you should reduce the amount an incoming investor(s) can invest if an existing shareholder wants to uptake preemption. At SeedLegals we almost never see this ever happening, because why would founders turn back to their investor(s) and say they can’t invest. Instead, founders prefer to take on more dilution to reduce/avoid the dilution of their existing shareholders and add them as participants of their new round.
To do that founders will need to add the preempting shareholder to the round and then just legally disapply the preemption right in the Shareholders Resolution in relation to all of the shares (you can do all of this on SeedLegals platform). This way existing shareholders participate in the round as cash investors and are treated just like any other new investor.
1. Calculating preemption as it’s legally intended
If the preemption notice has been sent, and an existing shareholder accepts the offer, the correct procedure is to subtract the number of shares claimed by that shareholder from the total number of new investor(s)’s shares. The shareholder will be added to the round as an investor, and the new investor(s) shares will need to be manually adjusted down.
2. Calculating preemption as it happens in practice (alternative procedure)
To simplify things for founders we created a calculator where you can calculate the amount you need to issue to your shareholders in just a few clicks.
Here’s how the calculator works: It assumes that if you’re taking in investment and if one - or more - shareholders want to uptake their preemptive rights you would end up taking in more cash, i.e. £X + £Y (where £X = the original investment and £Y = the amount the preempting shareholder needs to invest to maintain their existing shareholding %)
We’ve built a calculator to make this incredibly simple – click here
(You can also calculate preemption amounts yourself by following our formula below but the calculator is much quicker.)
Easily work out how many shares you need to issue
Here’s how you calculate the preemption amounts for your shareholders using our calculator.
Provide these inputs and make sure they are correct:
Total number of shares in the Company before the new funding round
Important: For the total number of shares you should only use the total number of issued shares, regardless of the status of the shareholder. You should include all shares of founders, shareholders, consultants, employees, etc., that exercised their options.
Price per share in the new funding round
How much £ is being raised in total
Once you’ve done that, just add:
Name of the shareholder
Number of shares they have before a new funding round
Then type 1 next to each shareholder that is willing to uptake preemption and 0 next to those who don’t.
You can now see:
Number of new shares the shareholder would have to purchase to avoid dilution
New % of shareholding after preemptive purchase (including the new diluted % for all shareholders who did not participate in preemption)
How much each shareholder needs to pay for the nearest whole number of shares
As well as:
Total number of shares to be issued to preempting shareholders
Total raised from preempting shareholders
New total number of shares that the company will have after the funding round and issuing shares to preempting shareholders
The math behind the calculator
Let’s look at an example…
You raise £2,000,000 in your new funding round at £0.60 per share. You got an indication from two of your existing shareholders that they’re minded to accept the preemption offer when you send it.
So, you decide to follow the alternative procedure instead. Now you need to calculate the number of shares you need to issue to two of your shareholders that would otherwise uptake preemption.
Total raised in the new funding round is £2,000,000 at £0.60 per share, an equivalent of 3,332,234 shares.
Total number of shares is 10,000,000 (before the funding round)
Total number of shares after the funding round is 13,332,234 (before preemption)
Before the funding round each of your would-be preempting shareholders holds 1,000,000 shares, an equivalent to 10% in your company.
Total owned by these shareholders is 2,000,000, an equivalent of 20% of the company.
The formula is:
Sum up % of investor shareholding that want to take up preemption. Two want to exercise their right, hence: 10% + 10% = 20%
Subtract 20% from 100%: 100 - 20 = 80
Sum up shares held by shareholders that want to take up preemption:
1,000,000 + 1,000,000 = 2,000,000
Subtract the sum of shares held by shareholders that want to take up preemption from the number of shares after the funding round (before preemption):
13,332,234 - 2,000,000 = 11,332,234
Divide 11,332,234 by 80*100 to get post preemption total number of shares:
11,332,234 / (80*100) = 14,165,292.50
Subtract 11,332,234 from post preemption total number of shares to get the new total number of shares to be held by shareholders that uptake preemption:
14,165,292.50 - 11,332,234 = 2,833,058.50
Subtract the sum of shares preempting shareholders owned pre-funding round from their post preemption total to get the number of shares you need to issue to fulfil the preemption offer: 2,833,058.50 - 2,000,000 = 833,058.50
Distribute between each individual pro-rata depending on their original shareholding:
Total number of shares (post preemption) * % of the shareholder’s holding before the funding round = total number of shares they have post preemption
14,165,292.50 * 10% = 1,416,529.250
Shareholder’s number of shares post preemption - Number of shares before funding round = Number of shares they have to purchase to avoid being diluted
1,416,529.250 - 1,000,000 = 416,529.250
Calculate the total amount each preempting shareholder needs to pay for the nearest whole number of shares: Number of Shares * Price per share in the Funding Round
416,529.250 * 0.60 = £249,917.55
Voila! You now know how many shares you need to issue, how much your existing shareholders need to pay to uptake preemption and how much you will have raised in total after issuing additional shares.