Preemptive Rights Clause
(Operating Agreement) (LLC)

Summary

This Preemptive Rights Clause (Operating Agreement) (LLC) may be inserted into the operating agreement of a limited liability company (LLC) to provide investors with the right to purchase more membership interests to maintain their percentage ownership of the LLC. This clause contains practical guidance and drafting notes. An LLC may need to raise additional capital from time-to-time after its formation to meet its day-to-day working capital needs or for investment in the long-term expansion of its business. However, if capital is raised from third parties, this will have a dilutive effect on the relative financial positions of current investors—the members. This concern can be addressed by the inclusion of a preemptive rights provision in the LLC's operating agreement. Preemptive or pre-emptive rights offer existing members a first priority right (essentially, a right of first offer (ROFO)) to cover the total value of the additional capital infusion sought by the LLC by increasing their individual aggregate level of investment on a pro rata basis. Accordingly, preemptive rights protect existing members against the involuntary dilution of their equity interests (i.e., their membership interests). In some states, a preemptive right is a default provision available to LLC members regardless of whether the LLC operating agreement provides for this. In other states, members may have preemptive rights only if the LLC agreement explicitly establishes this. Raising capital through a preemptive rights process can be time consuming. If it is anticipated, given the vagaries of the business sector in which an LLC will be engaged, that an LLC may be faced with situations when it needs to quickly raise additional capital, an ex post facto rights provision should be alternatively considered. In this case, the LLC's controlling members (or its manager) can first approach third party investors and then afford current members the opportunity to true-up their investments to the status quo ante by exercising their ex post facto rights after the new investors have been admitted as members (if this is possible for new investors under operating agreement). For a full listing of key content for in-house counsel and corporate secretaries when performing corporate functions, see In-House Corporate Secretary Resource Kit. For more information on operating agreements, see Limited Liability Companies and Operating Agreement and Initial Filing Requirements State Law Survey (LLC).