Preference shares – Dutch Uncles

What Does A Rights Issue Mean?

Aakash Sharma — Sat, 25 Sep 2021 08:35:09 +0000

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.

The post What Does A Rights Issue Mean? appeared first on Dutch Uncles.

Preference share: Types and How it Differs from Ordinary Shares

Shalmoli Sarkar — Mon, 20 Sep 2021 03:35:07 +0000

A majority of the new investors might not be aware, but a company issues two kinds of stocks in the market. One is common or ordinary shares owned by retail investors and, the other is preference shares. Let us dig deeper to know what they are and if investors should invest in such shares.

What are preference shares?

Preference shares also, known as preferred stocks are shares of a kind issued by a company where company profits or dividends are distributed first to the preference shareholders than the common shareholders. The dividends paid to the preference shareholders are fixed irrespective of variations in stock prices and company profits. The returns on these shares are generally higher than the dividend paid on the common stocks.

The power of preference share is such that if a company lands up in bankruptcy, then the amount generated by selling all company assets is first distributed amongst preference stock investors than the common stocks. The preference shares investors are generally mutual fund firms and financial institutions, and company issues such shares to generate more funds or money in a short time.

What are the types of preference shares?

There are many types of preference shares prevalent in India, below are some:

Cumulative shares: In this, if a company is not able to pay dividends due to a slump in revenues, then the company has to pay the previous dividend as well the current year’s dividend to the investor. Let us understand this with an example, suppose a company promises to pay a dividend of 10 % for 5 years to the investor. Say, In the first year, it could pay a dividend but in the second year it could not pay. Eventually, in the third year, it will be paying a 20% dividend adding 10% from the previous year and 10 % from the current year. The law forbids the company to make any dividend payment to common shareholders, unless and until the preference shareholders receive dividends.
Non-Cumulative shares: Unlike cumulative, if a company is not able to pay the dividend in a certain year, then in its consecutive year, it will pay only the current year’s dividend and not the previous years. Taking the above example, the company is liable to pay 10 % only to its preferential shareholders.

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Preferred stocks are shares of a kind issued by a company where company profits or dividends are distributed first to the preference shareholders than the common shareholders.

Convertible shares: In this, the shares are eligible to be converted into common shares after certain years. For instance, if a company issues a share certificate to its preferential shareholders mentioning that shares are convertible after 5 years, it means after 5 years the shares will become ordinary shares. In converted preference share, the individual will not be receiving any fixed dividend but will get the profits earned from the share price growth.
Non-Convertible Shares: Company cannot convert the preference shares into common shares.
Redeemable shares: The company has the right to buy back its shares from shareholders at a fixed date. Say, if the shares are redeemable after 4 years, which means that the company will purchase its shares from preference shareholders, at a price that was issued at that time.
Irredeemable or perpetual Shares: These shares can only be redeemed by the company at the time of liquidation or when the company shuts its operations but the shareholders will receive fixed dividends as promised. But, irredeemable shares are not allowed in India, as according to the Companies Act, 2013 all preference shares must be redeemed within 20 years.
Preference share with a callable option: It is similar to redeemable shares but with a difference. Here, the company has the right to purchase the stocks at a decided price after a pre-decided date.
Adjustable-rate preference share: In this, the dividend rate is not fixed as companies do not want to take the interest rate risk. The dividend is linked with the existing interest rate in the market.
Participating preference share: Apart from receiving fixed dividends, the preferential shareholders will receive the additional dividend difference on the common shares. This happens when the dividend on ordinary shares is more than the dividend of preference share. For example, if the dividend on the ordinary share is Rs 12 and it is Rs 10 on preference, then the company needs to pay Rs 12 ( 10+ {12-10}) for each preference shareholder.
Non-Participating preference Share: The shareholders are entitled to receive dividends at a fixed rate and will not receive benefits from the surplus profit. The extra profit is distributed among the common shareholders.

Ordinary shares vs Preference shares

Though both preference and ordinary shares promise ownership in a firm, they differ from each other.

Is preference share investment for retail investors?

Since preference shares are not traded on stock exchanges, it is not available for retail investors. A company rarely keeps its preference shares to be purchased by retail investors. But, in case anyone is interested he/she can invest in such shares of a company through their financial broker.

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