Rights Issue: What it is and Features

A Rights Issue of shares is a strategy used by companies to raise capital. In this approach, existing shareholders can buy additional shares at a discounted price. This approach not only secures funding for the company but also rewards and retains the loyalty of current shareholders by offering them a chance to increase their investment at a lower cost.

Let's take "Bright Future Schools," an educational institution looking to expand its campuses. To finance this expansion, they opt for a Rights Issue. They announce that every shareholder can buy new shares at a discounted rate. For example, if someone owns 200 shares, they're given the right to buy 40 more shares at a price lower than what the public pays. This approach allows Bright Future Schools to raise the necessary funds for expansion while giving their loyal shareholders a chance to invest more in the company's growth at a preferential rate.

Table of Content

• What is Right Issue?
• Features of Right Issue of Shares
• How Does the Right Issue Work?

What is Right Issue?

Rights Issue is a corporate financial strategy where a company offers its existing shareholders the opportunity to purchase additional shares, usually at a discounted price. This is done in proportion to their existing holdings, allowing shareholders to maintain or increase their stake in the company without dilution. Rights issues are typically used to raise new capital for expansion or debt repayment.

Features of Right Issue of Shares

Proportional Allocation of Rights

• In a rights issue, shareholders are allocated the right to purchase additional shares in proportion to their existing shareholding.
• This mechanism ensures fairness, allowing shareholders to maintain their percentage ownership in the company.
• For instance, in a "1 for 4" rights issue, a shareholder holding 100 shares would be entitled to purchase 25 additional shares.

Discounted Share Pricing

• Rights are typically offered at a discount to the current market price of the shares.
• This discount serves as an incentive for shareholders to participate in the rights issue, making it an attractive investment compared to buying shares on the open market.
• The discount also compensates for the potential dilution of share value due to the increase in the total number of shares.

Time-Limited Offer

• Rights issues are available for a limited period, known as the subscription period.
• Shareholders must decide within this timeframe whether to exercise their rights to purchase additional shares.
• If the rights are not exercised within this period, they usually expire and cannot be used.

Transferability of Rights:

• Shareholders who do not wish to purchase additional shares can often sell their rights on the open market.
• This provides flexibility, allowing shareholders to potentially profit from selling their rights if they do not have the funds or desire to increase their shareholding.
• The tradability of rights also adds liquidity to the market.

Capital Raising without Debt:

• A rights issue enables a company to raise capital without increasing its debt burden.
• This is particularly advantageous for the company as it avoids interest payments and the pressure of debt repayment schedules.
• The funds raised are typically used for various corporate purposes, such as business expansion, debt reduction, or strategic investments.

How Does the Right Issue Work?

Announcement of Rights Issue

The company announces its intention to issue new shares to existing shareholders, specifying the details such as the number of shares, the ratio of the rights offering (e.g., 1 new share for every 5 held), the price at which these shares will be offered, and the timeframe for the offer.

Setting the Record Date

The company sets a 'record date' to determine which shareholders can participate in the rights issue. Only shareholders on record as of this date will receive the rights to buy additional shares.

Issuing Rights to Shareholders

Following the record date, rights are issued to the eligible shareholders. These rights are often represented as 'rights certificates' and can be tradable, depending on the company's decision and market regulations.

Rights Trading

If the rights are tradable, shareholders who do not wish to purchase additional shares can sell their rights on the open market to other investors. This allows them to monetize the value of the rights.

Subscription Period

Shareholders can exercise their rights to buy additional shares for a limited period. If they do not exercise their rights within this timeframe, the rights expire.

Shareholder Decision

Shareholders can decide to:

a) Exercise their rights fully and buy the additional shares at the discounted price.

b) Sell their rights on the market if they are tradable.

c) Let the rights expire, which might dilute their existing shareholding if other shareholders exercise their rights.

Allocation and Issuance of New Shares:

After the subscription period ends, the company allocates and issues new shares to the shareholders who exercise their rights. The funds raised from this issuance are then used by the company for its stated purposes.

Adjustments in Share Market:

Post rights issue, the share price may adjust in the market, reflecting the increased number of shares and the capital raised.

Conclusion

A rights issue is a strategic tool for companies to raise additional capital by offering existing shareholders the chance to purchase more shares at a discounted rate. This method helps companies fund expansion, reduce debt, or improve financial stability without incurring additional debt.

For shareholders, it offers an opportunity to increase their investment at a favourable price while maintaining their ownership percentage. Overall, a rights issue can be beneficial for both the company and its shareholders when executed effectively.