A financing round is on the horizon. New investors are coming on board, the share capital is being increased – and suddenly a term comes up that receives too little attention: the pre-emptive right. For existing shareholders, it is a key protective instrument. For founders and new investors, its exclusion is often an operational necessity. Anyone unfamiliar with the mechanics risks either diluted existing shareholders, contestable shareholders’ meeting resolutions, or unnecessary transaction costs.
This article explains what pre-emptive rights are, when they become relevant in start-up financing rounds, how they can be excluded in a legally sound manner, what consequences an exclusion entails – and how capital increases can be structured so that a formal exclusion is not necessary at all.
What are Pre-Emptive Rights?
Pre-emptive rights are the statutory right of each shareholder, upon a capital increase, to subscribe to new shares in proportion to their existing shareholding. They protect against two forms of dilution: economic dilution (a reduced share in company profits and value) and voting dilution (loss of influence and voting weight).
The scope of pre-emptive rights is measured by reference to the nominal value of the existing holding, not the number of shares – a detail that becomes significant in companies with different classes of shares.
Pre-emptive rights constitute a hybrid membership right with both a patrimonial and a co-administrative component. They cannot be disapplied by the articles of association, but may only be restricted or withdrawn by a shareholders’ meeting resolution and only for good cause.
Relevance in Start-Up Financing Rounds
In early-stage companies – seed, Series A, Series B – pre-emptive rights are a central topic for several reasons:
- New investors receive shares that cannot be offered proportionally to existing shareholders. The pre-emptive rights of existing shareholders cannot be preserved.
- Employee participation programmes (ESOP/VSOP), where participation is effected through the issuance of new shares, likewise result in an exclusion for the other shareholders.
For founders and board members, the key point is this: without a legally sound basis for the exclusion, shareholders’ meeting resolutions are contestable – with corresponding risk for the entire transaction.
Exclusion of Pre-Emptive Rights: Requirements and Practice
Pre-emptive rights may only be excluded by the shareholders’ meeting resolution itself, and this requires a qualified quorum: two-thirds of the votes represented and the absolute majority of the nominal value of the shares represented. On the merits, an exclusion is permissible only for good cause.
Case law has developed three cumulative criteria that must be satisfied for good cause to be established: (1) a qualified substantive interest of the company, (2) observance of the principle of equal treatment, and (3) compliance with the principle of proportionality. The statute also expressly mentions (on a non-exhaustive basis) the following as good cause: (1) the acquisition of businesses, (2) the acquisition of parts of businesses or participations, and (3) employee participation.
Consequences of an Unlawful Exclusion of Pre-Emptive Rights
If the requirements are not met, significant consequences may follow: the shareholders’ meeting resolution is contestable. In the worst case, a contested capital increase may have to be unwound.
In addition, an affected shareholder whose pre-emptive rights have been unlawfully withdrawn may suffer a direct loss and may bring a liability claim against the board of directors.
Waiver of Pre-Emptive Rights: Financing Rounds Without Formal Exclusion
An alternative to formal exclusion that is frequently used in start-up practice is the individual waiver by existing shareholders of their pre-emptive rights. This approach is legally sound, avoids the requirement of the qualified quorum shareholders’ meeting resolution described above, and significantly simplifies the transaction – but it requires certain conditions that must be carefully observed in practice.
The basic concept
If each existing shareholder individually waives their pre-emptive rights in respect of the newly issued shares, the need for a shareholders’ meeting resolution on the exclusion falls away. The capital increase itself still requires a shareholders’ meeting resolution – however, a resolution to increase capital without an exclusion of pre-emptive rights requires only a simple majority.
Key Considerations for the Waiver
- Individuality: Pre-emptive rights are a personal membership right of each shareholder. The waiver must therefore be declared separately by each individual shareholder. In practice, an individual, dated, and signed waiver document per shareholder is recommended.
- Completeness: The waiver must be obtained from all shareholders holding a pre-emptive right in respect of the specific newly issued shares. If even one shareholder is missing, the statutory pre-emptive right applies to that shareholder’s portion – and the transaction faces a problem. In companies with multiple share classes (ordinary and preference shares), the circle of those entitled to pre-emptive rights must be assessed with particular care.
- Content of the Waiver: The shareholder must clearly understand what they are waiving. A valid waiver declaration should contain at minimum: the company, the date of the resolution to increase capital, the number and type of newly issued shares, the issue price, and the explicit statement that the pre-emptive right in respect of the relevant shares will not be exercised.
- Consideration and Equal Treatment: The waiver is in principle gratuitous – and this is legally unproblematic. However, if one shareholder receives compensation for their waiver while others do not, issues of equal treatment may arise.
Advance Waiver in the Shareholders’ Agreement (SHA)
In venture capital practice, shareholders’ agreements (SHAs) frequently contain a so-called waiver clause: shareholders commit in advance to waive their pre-emptive rights if future capital increases take place under certain conditions. This is common practice, although it is advisable to obtain a further waiver of pre-emptive rights at the time of the capital increase (e.g. in the investment agreement).
For financing rounds involving new investors, the following procedure is recommended:
- The SHA contains a waiver clause for future qualified financing rounds.
- At the time of the capital increase: obtain individual, written waiver declarations from all existing shareholders (e.g. in the investment agreement signed by all shareholders).
- The shareholders’ meeting passes a resolution to increase capital without an exclusion of pre-emptive rights (a simple majority suffices).
- New shares are issued directly to the new investor.
In practice, this procedure is the standard approach for small and medium-sized start-ups with a manageable number of shareholders – and at the same time the most elegant solution for completing a financing round in a legally sound, swift, and contestation-free manner.
Conclusion
Pre-emptive rights are not a mere formality. They are a genuine right of existing shareholders that – when excluded – requires a clear substantive justification. In the practice of small and medium-sized start-ups, the individual waiver by all shareholders is often the most pragmatic and legally sound route: it avoids the qualified quorum, does not require good cause, and keeps the capital increase lean from a transactional perspective.
Careful preparation is key: a waiver clause in the SHA, individual waiver declarations at the time of the capital increase, and clear documentation. Anyone who consistently applies these three elements will complete financing rounds in a legally sound and efficient manner – without the risk of a contestation on grounds of pre-emptive rights violations.
