What is the right issue of shares – Get All The Information

Key Takeaways:

1. A rights issue of shares is a method companies use to raise capital while maintaining the proportional balance of voting rights among existing shareholders.
2. It involves issuing new shares to shareholders at a discounted subscription price, known as preemptive rights.
3. Rights share offerings are common when companies need additional capital for expansion without debt financing.
4. Shareholders can exercise their rights, not participate, or renounce them, allowing others to buy at a discount.

Have you ever thought about the right issue of shares? Why do all finance experts need to understand it, along with terms such as shareholder’s rights, capital raising, dilution of ownership, and much more? 

Regardless of whether you are a financial expert with an enviable career behind you or you are just entering the financial waters, you must truly understand all these terms.

The following text will explain the right issue of shares, equity offerings, financial securities, preemptive rights, and much more. Let’s get to know the right issue definition, shall we?

What is the right issue definition? 

Once a certain company needs to raise additional capital while ensuring the proportional balance of voting rights among existing shareholders, it conducts a rights issue, a corporate finance strategy.

A rights issue, also known as an equity offering, involves issuing new shares to shareholders, granting them the privilege, or preemptive rights, to purchase these shares at a discounted subscription price.

This capital-raising method serves as a means of injecting fresh capital into the company without incurring underwriting fees. 

What is essential to note? 

However, it’s essential to note that if existing shareholders select not to exercise their preemptive rights by acquiring additional shares, their ownership may face dilution as the new shares are issued. 

A rights issue is a shareholder’s right to maintain their ownership stake by participating in the capital injection process or deciding to forego it.

Motives for a Rights Share Offering

When a publicly traded company plans to expand its operations, it may find itself in need of additional capital for various reasons, such as settling debt, acquiring assets, or purchasing another company. 

Instead of debt, which entails interest payments, they may opt for equity by issuing new shares. In this process, known as a rights share offering, existing shareholders are granted the privilege, or the special right, to purchase these additional shares. 

This particular shareholders’ privilege allows shareholders to participate in the company’s capital expansion and impact crucial financial metrics, including the company’s earnings per share and the balance sheet.

Where are the rights share offerings common? 

Rights share offerings are particularly common among public companies seeking to bolster their financial resources. 

This method of capital expansion is often preferred when debt financing is either unavailable, unsuitable, or too costly, and it involves the participation of investment banking firms to facilitate the issuance.

Furthermore, these offerings can help companies in their efforts to enhance their debt-to-equity ratio and improve their financial position. 

By carefully managing rights share issuances, companies can strategically optimize their balance sheets while allowing existing shareholders to invest further in the company’s growth.

What are the two methods to participate in the right issue?

There are two methods to participate in a rights issue:

1. If your bank offers ASBA (Application Supported by Blocked Amount) services, you can conveniently apply online, similar to an IPO application.
2. If your bank does not support ASBA, you would have received a physical Composite Application Form (CAF) via courier from the company’s Registrar and Transfer Agent (RTA).

What is the best example of the Right Issue?

Consider Mr. Smith, an investor holding 800 shares of ABC Corporation, each valued at $12 on the stock market. When the company announces a 3-for-7 rights issue at $8 per share, it allows Mr. Smith to obtain additional shares.

Before this rights issue, Mr. Smith’s portfolio comprised shares worth $9,600. He invested $2,736 to acquire 342 right shares, increasing his total share count to 1,142. 

Following the completion of the rights issue, the value of his portfolio climbed to $12,336, resulting in a per-share price of approximately $10.80.

It’s essential to note that the market value of these shares may fluctuate on stock exchanges, impacting Mr Smith’s gains or losses and influencing the cash flow within his investment portfolio.

Is it necessary to subscribe to Right Issue?

When a company announces a rights issue, shareholders have three options:

1. Exercise Rights: Buy additional shares at Rs 1,257/share (vs. market price of Rs 1,466).
2. No Application: Do not participate in the rights issue.
3. Renounce Rights: Sell rights to someone else at a 14% discount; they get 6 shares at Rs 1,257/share.

By renouncing, you earn a 4% commission (Rs 301.68) on 6 shares at Rs 1,257 each. Your new cost per share is Rs 1,396.65, still lower than not participating.

Should you invest in the Right Issue of shares?

There are many reasons you should consider investing in the right issue of shares. Primarily, there are a lot of advantages, such as: 

1. Discounted Share Price: Existing shareholders can purchase additional shares at a reduced price. This allows them to expand their ownership stake in the company at a lower cost, lowering their average holding price for its shares.
2. Debt Reduction: For the company itself, a rights issue is one of the most effective means to raise capital without resorting to additional debt from banks at potentially high interest rates. This strategic approach helps the company cut down on its finance costs, leading to a healthier financial position and reduced interest expenses.

Bottom line

In summary, a rights issue is a corporate finance strategy an issuing company utilizes to raise additional capital while ensuring the proportional balance of voting rights among existing shareholders, thus preventing share dilution. 

This involves a secondary offering of new shares to shareholders, granting them the privilege of purchasing them at a discounted subscription price. It’s a cost-effective way for the issuing company to raise capital, avoiding underwriting fees and expanding its total share count.