Rights Issue

A rights issue is a crucial corporate finance strategy used by companies to raise capital by offering additional shares to existing shareholders. These rights are typically offered at a discounted price to the current market value, allowing shareholders to maintain their proportional ownership in the company.

Rights issues can be an excellent method for businesses to access funds for expansion, pay off debts, or restructure without relying on external investors.

In this guide, we’ll break down everything you need to know about rights issues, from how they work to their advantages and disadvantages for both companies and shareholders.

How Does a Rights Issue Work?

A rights issue allows existing shareholders the option to purchase new shares at a specific price, often lower than the market price. The company sets a ratio for the rights issue, determining how many new shares a shareholder can buy for every share they currently hold. For instance, a company might offer one new share for every two shares a shareholder already owns.

The rights are usually renounceable, meaning shareholders can sell or transfer their rights to others if they do not wish to exercise them. However, if the rights issue is non-renounceable, shareholders must exercise their rights or forfeit them.

Key Benefits of a Rights Issue

Capital Raising for Companies
A rights issue is an efficient way for companies to raise substantial capital. Since the offer is targeted at existing shareholders, the company avoids the need to go through the time-consuming and costly process of securing external investors.

Discounted Price for Shareholders
The biggest advantage of a rights issue for shareholders is the opportunity to buy additional shares at a discounted price. This offers the potential for greater profits if the company performs well and the share price increases after the rights issue is complete.

No Ownership Dilution
When a rights issue is offered, shareholders have the option to purchase the new shares in proportion to their existing holdings. This helps prevent the dilution of ownership. Unlike public offerings, where new investors can come in, a rights issue ensures that the current shareholders maintain control.

Disadvantages of a Rights Issue

Risk of Shareholder Involvement
Not all shareholders may have the funds to purchase the new shares, which could lead to an under-subscription. This means that the company may not raise as much capital as it intended, potentially affecting its financial goals.

Short-term Impact on Share Price
Although rights issues are meant to benefit shareholders, they can sometimes result in a temporary drop in share price. This happens because the market sees the increase in the number of shares as a dilution of earnings.

Not Always Fully Subscribed
A rights issue can be unsuccessful if there isn’t enough shareholder interest, leading to a shortfall in capital. If too few shareholders decide to exercise their rights, the company might not be able to raise the intended funds.

The Rights Issue Process: A Step-by-Step Breakdown

Here’s a step-by-step look at how a rights issue typically unfolds:

Announcement of the Rights Issue
The company announces the rights issue to its shareholders, explaining the terms of the offer, including the price, the ratio of new shares to existing shares, and the timeline for exercising the rights.

Offering Rights to Shareholders
Eligible shareholders receive the offer to buy new shares at the discounted price. This is often sent via a formal letter or email, along with instructions on how to exercise the rights.

Subscription Period
Shareholders have a specific period (usually 2-4 weeks) to decide whether to exercise their rights, sell them, or let them expire. During this period, they can also sell their rights if the offer is renounceable.

Completion of the Rights Issue
At the end of the subscription period, the company calculates how many new shares were subscribed to and issues them accordingly. If there is an under-subscription, the company may either cancel the unclaimed shares or attempt to place them with external investors.

Impact on Shareholders and the Stock Price

A rights issue can affect both the stock price and the value of individual shareholders’ holdings. Initially, the stock price may fall, reflecting the dilution of shares. However, once the rights issue is complete and the company uses the capital to grow or pay off debt, the stock price could rebound.

For shareholders who choose to exercise their rights, their holdings are not diluted, and they benefit from the discounted price, assuming the company uses the funds wisely.

Should You Participate in a Rights Issue?

Deciding whether to participate in a rights issue depends on several factors:

• Financial Position: Do you have the funds to exercise the rights?
• Company’s Prospects: Do you believe the company will use the funds effectively to grow and increase shareholder value?
• Market Conditions: Will the company’s stock price increase post-issue, making your new shares more valuable?

If you’re uncertain, you can sell the rights to other investors if they are transferable, which could give you a return without needing to buy more shares.

Rights Issue as a Tool for Growth

A rights issue can be a powerful way for companies to raise capital, especially in times of financial need. It provides existing shareholders with the opportunity to invest more in the company at a discounted price. However, like any financial decision, it comes with risks, and understanding how a rights issue works and how it might impact your portfolio is essential.