A ‘Rights Issue’ is a way for companies to raise money. In a rights issue subscription offer, the company entitles shareholders to buy new shares at a discount to the existing offering. This practice is more common in companies with limited liquidity that exercise the right to raise funds under challenging times.
A rights Issue allows shareholders to buy new stocks lower than the market price on a specified future date. In simple terms, the company enables shareholders to increase their portfolio shares holdings at a special discount.
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The rights issue is a proposal to subsisting shareholders to acquire additional new shares in the company. This issue provides existing shareholders with securities known as rights.
Why do companies offer a Rights Issue?
Companies often issue rights offering to raise more money. They majorly take this route for fulfilling fund requirements and support the operations and services of the firm. Companies with bad financial health and troubled conditions for a myriad of reasons often use rights issues to pay a debt, especially if they can no longer borrow from other sources.
However, the rights issuing process is not always conducted due to inadequate financial conditions. Companies with a good history also use it to raise funds to compete or develop new products by licensing new entities. This ultimately creates substantial monetary value for shareholders.
Company-Shareholder relationship concerning right issue
The issuance of rights affects two essential aspects of a company: market capitalisation and equity capital. As share capital increases in a rights issue, the company’s capital base expands with newly issued shares.
A company’s market capitalisation effect is based on understanding the market. Theoretically, any new rights issue by a company is more prone to garnering negative consequences. Therefore, the market capitalisation value does not decrease as the number of shares increases post rights issuance.
However, suppose the influence of the market suggests that there are good reasons for raising capital by the issue. In this case, the share price may rise, causing the market cap to increase.
If shareholders do not want to exercise the right to buy the new-discounted shares, they can sell the rights on the stock exchange as they are tradeable entities. Alternatively, investors can allow the rights issue to lapse.
What should an investor be concerned about in case of a rights issue?
Investors should be careful when their invested company issues rights before acting on the offering. Rights issues for extra shares are separate from the bonuses that companies pay to equity holders. It would help if you only accepted the rights issue offering after learning the motives behind the fund-raising process. If you are confident that the company is doing well financially and on a growth trajectory, you can accept the offer. But, if the share price has fallen below the subscription price, it may be cheaper for an investor to buy the stock on the open market instead of the rights offering.
Process of applying
For investors, the process of applying for a rights issue is done through Applications Supported by Blocked Amount (ASBA). If your bank approves it, you can administer it online, just like an IPO. If not, then a courier of the Composite Application Form (CAF) from RTA (Registrar and Transfer Agent) of the company is needed.
You are required to complete the form, which has the rights issue information displayed on it. The basics include the Rights Issue ratio and the book closure date. You must submit it at a Self Certified Syndicate Banks (SCSB) branch. The list of banks is given on the application form.
Example
Suppose an investor A had 100 shares of Company X at a total investment of Rs. 40,000. S/he bought the shares at Rs. 400 per share. The stock amount did not vary between the purchase date and the date the rights were issued.
Considering a 1:1 subscription rights issue at a proposal price of Rs. 200, A will be informed by a broker-dealer that s/he can pay for an additional 100 shares of the firm at the offer (discount) price.
Now, if s/he exercises this option, s/he will have to pay an additional Rs. 20,000 to acquire the shares, thus effectively bringing the average acquisition cost for the 200 shares to Rs. 300 per share.
40,000+20,000 /200 => 300 (here, average cost of acquisition = initial total cost + cost after rights issue / cost of one share after rights issue).
Thus, A will effectively acquire the shares at a discounted price of Rs. 300 as part of Company X’s rights issue against the market price of Rs. 400.
Benefits
- A company can grant rights offering to its shareholders at a discounted price without incurring underwriting fees.
- It is a quick source of funding. Shareholders of the company can buy new shares in the related issue at a discount for a specified period.
- Companies can raise capital without increasing debt. The extent of the right issue is essentially in the form of equity, and it eliminates any range for debt.
Disadvantages
- It may reduce the share of current shareholders. Existing shareholders can either “subscribe” to the rights issue or “ignore” it. If a shareholder ignores the offering, the shareholding percentage dilutes. If more shareholders’ ignore’ the issue, there are chances of stake dilution of the existing shareholders.
- After the right issue, some shares are introduced at a reduced rate. This changes the previous price of the shares by dilution. The new shares spread a company’s profits over a larger shares pool; hence, the dilution.
- It could indicate a corporate income crisis. In case of a fiscal emergency, companies generally choose to explore the rights issue option. Such an offering could lead shareholders to assume that the company is struggling, and they might sell their shares, leading to further share price reduction.
