Understanding about preemptive right to buy shares

1.What is a preemptive right to buy shares?

A preemptive right to buy shares refers to the right of existing shareholders in a company to purchase new shares before they are offered to the public or to third parties. Whenever a company chooses to raise capital by issuing new stocks, these shares cannot be made available to any other investors or listed on the stock exchange without a portion of its first being offered to the current shareholders of the company.

This preemptive right only applies in the scenarios where the company offers its shares, not applicable to the issuance of bonds, convertible notes and other securities. This type of right is typically specified in a company's articles of incorporation or bylaws. When the company issues new shares, it shall also notify its shareholders about the regulations on the purchase of the prioritized shares, in which the amount of shares that the shareholders are entitled to buy is determined by their shareholding proportion in the company.

Preemptive right to buy shares allows existing shareholders to purchase newly issued shares before they are offered to other investors.

Preemptive rights to buy shares have a significant importance to the shareholders of a company. The main purpose of this right is to protect the existing shareholders’ interests by enabling them to maintain their ownership percentage in the company. This is why majority shareholders who own a large ownership percentage are the ones who have most interest in preemptive rights, as they want to preserve their privilege in voting rights, decision-making power and other controls over the company. Exercising the preemptive right, existing shareholders can ensure that their ownership percentage is not diluted (in both value and control) by new investors when the company and its number of shares grow. In addition, preemptive rights also guarantee stability in the ownership ratio of the enterprises when they aim to seek for external investment capital.

2.Characteristics of preemptive right to buy shares

Besides the right to be first offered the new shares, preemptive rights to buy shares also include several other priorities that may benefit the investors who hold these rights during the issuance and in their future strategy. These priorities are meant to serve for the interests of shareholders, typically early investors, founders, or other major stakeholders who play an important role in the company. Some primary characteristics of preemptive rights to buy shares are:

a) Priority on price:

Normally, the subscription price for a company’s current shareholders in all types of preemptive rights is lower than the current trading price of the shares at the time the right is issued. This means that shareholders of a company will get opportunities to buy the additional shares at a preferential price compared to the price when they are offered to third parties or to the public later on the stock exchange market.

Existing shareholders are entitled to buy additional shares at a lower price compared to their market price.

The reason why the existing shareholders are offered a lower price is to protect their benefit as first buyers of the new shares. There may be risk of unfavorable factors occurring during the term of exercising the preemptive right, which leads to decrease in the market price of the trades shares and apparently affects the intrinsic value of the stakeholders’ ownership. In addition, the difference between the market price and the prioritized price also makes the new share more attractive to the current shareholders, ensuring their financial interests and loyalty towards the company.

b) Priority on order to buy shares

The most primary privilege of preemptive right to buy shares is that it grants shareholders the priority to purchase the new shares first, before any other investors. Whenever a company decides to offer a new issuance of stock, they will have to reserve a portion of those shares specially for the current shareholders. Only after the shareholders complete their exercising of preemptive rights, the remaining shares are then allowed to be offered to third party purchasers. Typically, the preemptive right will last for a short term of around 2-4 weeks. Within this period of time, the shareholders shall submit their subscription form to the company. Otherwise, it will be considered that the shareholder has waived their preemptive right to buy shares.

c) Transferable

Existing shareholders of a company are granted the preemptive right to purchase additional shares first, but not the obligation to do so. According to the provisions of Clause 2, Article 124 of the Enterprise Law 2020, shareholders have the right to transfer their preemptive right to purchase shares to others. Generally, if shareholders are unwilling or unable to exercise their preemptive right, they can sell or transfer this right to other shareholders or parties. The regulations regarding transfer of preemptive right to buy shares will be set out in the company’s notice sent to the current shareholders when issuing new shares.

Normally, the priority to buy shares is beneficial to existing shareholders as they can purchase new shares at a preferential price. However, when the stock market shows negative signs, the existing shareholders may not desire to increase their shares volume and would rather sell their preemptive right for immediate cash. However, it is imperative to note that in such cases where the shareholders do not exercise their right or transfer the right to other parties, their ownership proportion may decline and lose them a certain control and power over the company.

Preemptive right to buy shares can be transferred to other shareholders or third parties.

3.How does preemptive right to buy shares work?

Typically, the most common way companies seek to raise capital is by issuing new shares and almost all shareholders may want to claim their preemptive right to buy shares. In these issuance, both the company and the shareholders must follow specific procedures to ensure a smooth share offering and prevent unwanted miscommunication.

During the General Meeting of Shareholders regarding the decision to issue additional shares, the company needs to determine several details such as: the total number of shares to be issued, the number of shares shareholders are entitled to buy and subscription price. Afterward, the company shall send a written notification to the shareholders informing them about the share offering and their opportunity to purchase these additional shares through a preemptive right.

As for the existing shareholders, upon receiving the notification from the company, they must indicate their interest in buying the shares and submit the subscription form by the assigned deadline to claim their preemptive right to purchase the shares. Once the payment for the purchase is completed, the company will then issue the new shares with certificates to the shareholders, recognizing their proportion of ownership.

In the case a shareholder does not wish to exercise their preemptive rights to buy the shares, they will simply skip the opportunity. Later after the term of the preemptive right expires, the remaining shares will be offered to other investors or traded on the stock exchange for all investors.

4.Advantages and disadvantages of preemptive right to buy shares

Although preemptive rights to buy shares are mainly beneficial to the majority shareholders who own a large proportion of the ownership in the company, it also established a mutually beneficial relationship for both the company and its shareholders. However, it is worth noting that there are advantages and disadvantages of using the preemptive right to buy shares.

a) Advantages of preemptive right to buy shares:

For existing shareholders

• Purchasing shares at a beneficial price.

• Maintaining or increasing their shareholding percentage in the company.

• Protecting power and control over the company.

For the company

• Maintaining a stable ownership structure.

• Saving more time, costs and resources than acquiring new investors, hence increasing the company’s value.

• Ensuring that the new shares are offered to investors who are already committed to the company's growth and success.

b) Disadvantages of preemptive right to buy shares

For existing shareholders

• Risk of dilution of ownership and reduction in earnings per share when there are more shares in the market.

• Shareholders who are not interested or unable to exercise their preemptive rights may see a reduction in their ownership percentage.

For the company

• Limiting the flexibility in accessing new investors.

• Risk of facing hostile acts from outsiders or competitors in gaining control over the company by buying a large number of newly issued shares

5.Information regarding preemptive right to buy shares in Vietnam Law on Enterprise 2020

Initially, the preemptive right to buy shares was commonly comprehended to be applied in the cases where the company chose to issue its shares through the method of offering shares to existing shareholders. Earlier versions of Law on Enterprise did not mention or indicate any other specific cases where this preemptive right needed to be preserved for existing shareholders. As a result, when companíes decided to carry out a private placement or a public offering of shares, they would not be obliged to consider the assertion or refusal of preemptive right from existing shareholders.

However, the latest version of Law on Enterprise which was issued in 2020 has prescribed a change in the regulations on private placement of shares. According to Clause 2, Article 125, except for the case of mergers and acquisitions, when a joint stock company decides to make a private placement of shares, its existing shareholders shall be offered to buy those new shares first. Only if the shares are not completely bought by the shareholders and the transferee of the preemptive rights, the remaining amount of shares shall be offered in the form of private placement.

Basically, the preemptive right to buy shares has been recognized as mandatory from the time the Law on Enterprise 2020 was issued. Although the new regulation has clarified an unclear point in the earlier versions, it may create several risks and obstacles when a company aims to raise capital through a private placement. Therefore, it is essential that companies consider their capital raising plan carefully and ensure compliance to the new regulation to avoid time-consuming and unnecessary costs in the process of carrying out a share issuance.

Conclusion

Preemptive right to buy shares is an important tactic that brings significant benefits to both the company and its existing shareholders, as it preserves the stability in the ownership structure and hence ensures the control power of important stakeholders. On the other hand, the new regulations governing preemptive rights may confuse companies and stakeholders, requiring involved parties to be careful along the procedures to ensure a smooth issuance of shares.

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