One might assume that when a company is listed, it has much more capital than before, especially when it has sold a stake in its IPO. But companies are usually in need of cash for different reasons. It could be for business expansion, clearing off existing loans and debts, and any other plan that the board of directors has cleared. One creative way of raising capital, especially for companies tight on cash, is the rights issue of shares. Now what is right issue of shares market?
We’re going to explain what are rights issues, how it works, and their purposes.
What Is Right Issue of Shares?
When companies need cash, they offer investors something known as a rights issue. A rights issue gives the existing investors the right, not the obligation, to buy new shares of the company, but at a discounted price. The discount is from the current trading price of the shares. The rights issue is dependent on the number of shares held by investors and is given out proportionately to their shareholding.
A rights issue shouldn’t be confused with a bonus issue. In the latter, investors are getting shares issued from the company’s reserve capital, without paying any additional money. A rights issue requires investors to pay for the extra shares, even though it is being issued at a discount to their market price.
Read More : What are Right Issues? And How it affect your investments?
Purpose Of Right Issue of Shares:
- A right issue is usually given out by a cash-strapped company looking to clear off its debt. The shareholders who are eligible for the rights issue have the right to buy the shares, but not a mandate. They can refuse to purchase additional shares if they don’t deem it valuable to them.
- The company doesn’t have to incur underwriting fees when raising money through rights issues. Instead of raising funds through debt, which has regular interest payments, companies may choose to raise funds through issuing equity. It also speeds up the process of raising funds.
- Companies that are seeking to buy a new company or improve their D/E ratio may also look to raise funds this way.
- A rights issue is a privilege given to existing shareholders of the company. They can choose to opt out of the rights issue and not buy additional shares. If you do agree to buy the rights issue, you have to pay a certain amount to the company. The amount you pay for a subscription is based on the rights issue price and the number of shares eligible for the issue.
- Investors should be aware that if they decide to opt out of the rights issue, the company issues additional shares to the other shareholders and thus diluting their holdings.
Also Read: Types of Shareholders – Meaning, their Rights and Responsibilities
Rights Issue: How It Works
To understand how a Rights Issue works, we’ll use an example of a hypothetical rights issue by a company DMX. Assume an investor owns about 200 shares in DMX, currently trading at ₹100 per share.
DMX announces a rights issue in a ratio of 1 for 5, meaning that for every 5 shares held, investors will be eligible to buy 1 additional share.
Now keep in mind that rights issues are sold at a discounted price. DMX also states that the discounted price of the share will be ₹60. So for every 5 shares held (worth ₹100 each) by an investor, the company is willing to offer 1 share at a discount of ₹60 per share.
Here are the key observations from an investor’s perspective, about this rights issue of shares:
- Investor’s Shareholding value (Before Rights Issue) = 200 shares * ₹100 = ₹20,000
- Number of right shares to be received = 200*⅕ = 40
- Price of the discounted rights shares = 40 * ₹60 = ₹2,400
- Total number of shares after participating in rights issue = 200 + 40 = 240 shares
- New Portfolio Value = ₹20,000 + ₹2,400 = ₹22,400
- Average Price of investor after rights issue = ₹22,400/ 240 = ₹93.3 per share
Going by the example stated above, the price of the shares of an existing investor who participated in the rights issue will be ₹93.3. But that’s only in theory. The investor benefits immensely if the share price of the company goes up. But if the price of the share falls below ₹93.3, the investor is exposed to losing money on his investment. But the price fall risk isn’t hypothetical.
There are certain reasons why the share price would decline:
- Rights Issues might signal to investors that the company’s doing poorly in terms of financial management, sending investors into a selling spree.
- A rights issue dilutes the value of shares that are already available in the market, which will inevitably drop the share price.
In Closing
Every company at some point finds itself in need of capital. That doesn’t necessarily mean that they are performing poorly or are in serious debt. In fact, reducing debt is just one of the reasons they need to raise funds. It could also be to acquire a company or expand their business without bearing heavy interest costs. As an investor, it is important to know the reason for the rights issues before making a decision. If you have additional capital, and find the company’s long-term view appealing, then you should consider the added advantages. We hope this article answers your question on “What Is Right Issue of Shares?” and you found it informative.
FAQ
1. How long does a rights issue take?
The duration of a rights issue can vary depending on the specific circumstances and the regulatory requirements involved. Typically, it may take a few weeks to a couple of months to complete the process.
2. What are the benefits of rights offerings?
The benefits of a rights offering include improving the company’s balance sheet, eliminating debt, injecting new cash flow, raising market interest, attracting new investors, and potentially increasing the share price.
3. How do I buy rights issue shares?
To buy rights issue shares, shareholders can use the ASBA process if their bank supports it, or the RTA will send a CAF via courier for those who cannot apply online.
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