Pre-emptive rights (or rights of first refusal) protect preferred stockholders against dilution from subsequent equity sales by a venture capital- or private equity-backed company.
Such a right provides that, if the company engages in a subsequent equity sale, a preferred stockholder can purchase the number of shares required for it to own the same percentage of the company after the sale as it did before the sale. The preferred stockholders have the right to purchase shares in the sale on the same terms and conditions (including price per share) as outside investors. If a preferred stockholder chooses not to exercise its pre-emptive rights or is unable to do so because it lacks sufficient funds, the preferred stockholder will be diluted proportionately by the new equity sale.
This post was written by Matthew D’Ascenzo.