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What is right issue of shares?
When a company needs to raise additional capital and keep the voting rights of the existing shareholders proportionately balanced, the company issues rights shares.
A rights share issue is an offering of rights given to a company's existing shareholders, allowing them to purchase additional shares directly from the company at a discounted price, rather than buying them through the secondary market. The number of additional shares that a shareholder can purchase depends on their existing holding.
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How a Rights Issue Works
A rights issue allows a company to offer its existing shareholders the option to purchase additional shares at a discounted price for a limited period. The number of shares offered is usually proportional to the number of shares already owned. For example, in a 1-for-5 rights issue, shareholders can buy one new share for every five they hold.
Once the rights issue is announced, eligible shareholders receive rights entitlements. They can choose to subscribe fully, partially, ignore the offer, or sell their rights if they are renounceable. If a shareholder decides to subscribe, they pay the discounted price to receive the additional shares.
After the rights issue is completed, the company receives fresh capital. However, since more shares are added to the market, the value of each share may decrease slightly, resulting in dilution. Still, it helps the company raise funds while giving shareholders the chance to maintain or increase their ownership at a lower cost.
Features of Right Issue of Shares
● Corporations issue rights when they need cash for various purposes. This process allows the company to raise funds without incurring underwriting fees.
● A rights issue gives existing shareholders preferential treatment by giving them the right, rather than the obligation, to purchase shares at a lower price on or before a certain date.
● Existing shareholders also have the right to trade with other interested market participants until new shares are available for purchase. Rights shares are traded in the same manner as ordinary equity shares.
● The number of additional shares available to shareholders is generally proportional to their existing shareholdings.
● Existing shareholders may choose to forego the rights shares. However, if they do not purchase additional shares, their existing holdings will get diluted once the additional shares are issued.
Reasons for a Right Issue of Shares
● Business Expansion
Companies often raise funds through rights issues to support growth plans such as launching new products, entering new markets, or building new facilities.
● Debt Repayment
A rights issue helps reduce existing debt and interest burdens by raising capital without borrowing further.
● Improving Financial Health
Struggling companies may use rights issues to stabilise their balance sheets and improve their debt-to-equity ratio.
● Funding Acquisitions
Companies may issue rights shares to raise money for mergers or acquiring other businesses.
● Avoiding High Borrowing Costs
When loan options are expensive or limited, companies prefer equity-based funding like rights issues.
● Faster Fundraising Method
Rights issues are quicker and more efficient than public offerings, as they target existing shareholders directly.
● Retaining Ownership Control
By offering shares only to current shareholders, the company avoids bringing in outside investors, maintaining ownership structure.
Example of a Rights Issue?
Arun owns 1000 shares of XYZ Ltd. trading at Rs. 10 each. The company then announces a rights issue in the 2-for-5 ratio. The company announces the issue at a discounted price of Rs. 6 per share. Therefore essentially, for every 5 shares at Rs. 10 each, held by an existing shareholder, the company will offer 2 rights shares at a discounted price of Rs. 6.
Arun’s Portfolio Value (before rights issue) = 1000 shares x Rs. 10 = Rs. 10,000
Number of right shares to be received = (1000 x 2/5) = 400
Price paid to buy rights shares = 400 shares x Rs. 6 = Rs. 2400
Total number of shares after exercising rights issue = 1000 + 400 = 1400
Revised Value of the portfolio after exercising rights issue = Rs. 10,000 + Rs. 2400 = Rs. 12,400
Should be price per share post-rights issue = Rs. 12,400 / 1400 = Rs. 8.86
In theory, the share price after the rights issue should be Rs. 8.86; however the market value may differ. An uptrend in the share price will benefit the investor, while if the price falls below Rs. 8.86, he will lose money.
Calculations
Let’s say you own 1,000 shares of a company currently trading at ₹10 per share. The company announces a 2-for-5 rights issue at a discounted price of ₹6 per share. This means for every 5 shares you hold, you can buy 2 additional shares at ₹6.
Eligible Rights Shares = (1,000 × 2/5) = 400 shares
Cost to Subscribe = 400 × ₹6 = ₹2,400
Total Shares After Rights Issue = 1,000 + 400 = 1,400 shares
Total Investment Value = ₹10,000 (original) + ₹2,400 (new) = ₹12,400
To find the theoretical ex-rights price:
Ex-rights Price = ₹12,400 / 1,400 = ₹8.86 per share
This shows how rights issues affect shareholding and price dilution. The actual market price, however, may vary based on demand and market sentiment.
Advantages for Company & Share holders
Right issue of shares offer several advantages to both companies and shareholders in a straightforward and efficient manner.
For the company
- Quick and Direct Funding: Rights issues allow companies to raise money quickly by offering more shares to their existing shareholders. This is useful for funding projects, reducing debt, or expanding the business.
- Cost-Effective: Compared to other ways of raising funds, like taking on debt or launching an IPO, rights issues are cheaper since they avoid high fees and keep the process simple.
- Ownership Control: By giving the first chance to existing shareholders, the company can avoid bringing in new investors and maintain control over its direction.
For shareholders
- Exclusive Opportunity: Shareholders get the first chance to buy more shares at a discounted price, allowing them to increase their investment at a lower cost.
- Ownership Stability: By participating, shareholders can maintain their ownership percentage, ensuring their influence in the company stays the same.
- Potential Profit: If shareholders choose not to buy more shares, they can sell their rights in the market, potentially making a profit without risking dilution.
Disadvantages of a rights issue
While a rights issue can offer benefits, it also comes with certain drawbacks that both companies and shareholders should consider.
● Dilution of Share Value
Issuing new shares increases the total number of shares, which may lower the earnings per share (EPS) and reduce the value of existing shares.
● Negative Market Perception
A rights issue may signal that the company is facing financial trouble, which can shake investor confidence and affect stock price performance.
● Shareholder Pressure
Existing shareholders may feel obligated to invest more money to maintain their ownership percentage, even if they’re not in a financial position to do so.
● No Guaranteed Gains
Even though the shares are offered at a discount, the stock price may fall below the issue price, leading to potential losses.
● Short Subscription Window
The limited time frame to act may not suit all investors, especially those who are not actively tracking the market.
Conclusion
A right issue of shares benefits existing shareholders, offering them the advantage of applying for shares at a discounted price and retaining their voting rights. A company can raise a reasonable amount of capital through the rights issue of shares.
