Rights Issue

Introduction

A Rights Issue is a corporate action where a company offers existing shareholders the opportunity to purchase additional shares at a discounted price, typically in proportion to their existing holdings. This mechanism enables companies to raise capital by offering shareholders the first right to buy the newly issued shares before selling them to the general public.

In this detailed guide, we will explore the concept of the right issue, its importance, and how it works. We’ll also explain various terms related to rights issues, including ASBA rights issues, SEPC rights issues, and bonus issues vs rights issues. Additionally, we’ll discuss rights issue examples, the steps to participate in a right issue, and the impact of rights issues on share prices and shareholder value.

What is a Rights Issue?

A right issue refers to an offering of new shares to existing shareholders, giving them the “right” to purchase additional shares, usually at a discounted price compared to the current market price. The company offers these shares in proportion to the shareholder’s existing ownership, allowing them to maintain their proportional stake.

• Purpose: Companies typically use a rights issue to raise capital for expansion, pay down debt, or fund other business activities without resorting to external financing sources like banks or venture capital.
• Discounted Shares: The key feature of a rights issue is the offering price, which is usually lower than the market value of the stock at the time of the announcement. This incentive encourages existing shareholders to participate.

How Does a Rights Issue Work?

Announcement:

The company specifies the number of shares it will issue, the offering price, and the ratio of new shares to existing shares when announcing the right issue. For example, a company might announce a 1:4 rights issue, which means shareholders can buy 1 new share for every 4 shares they currently hold.

Application Period:

The company sets an application period during which existing shareholders can exercise their rights. If shareholders choose not to participate, they can allow their rights to lapse, or in some cases, they may sell their rights on the open market.

Rights Trading:

Rights can be traded on the stock exchange. Shareholders who do not wish to purchase additional shares can sell their rights to other investors who may want to buy the shares at a discount.

Allotment:

After the application period ends, the company allocates the shares to those who subscribe to the rights issue.

Share Price Impact:

Upon completion of the rights issue, the company will issue new shares, and typically, the share price may fall because of the increased number of shares in circulation. This dilution of earnings can affect the stock price, although the discount on the right issue price could make up for the decrease.

Key Terms Related to Rights Issue

Rights Issue of Shares

A right issue of shares is the process by which a company offers additional shares to its existing shareholders at a discounted price, allowing them to maintain their ownership percentage. This can be an attractive option for companies needing capital but wanting to avoid the dilution and high costs of issuing shares to the public.

What is a Rights Issue?

A right issue provides existing shareholders with the right to buy additional shares in proportion to their existing holdings. The price is usually offered at a significant discount to the current market price, encouraging shareholder participation.

ASBA Rights Issue

ASBA (Application Supported by Blocked Amount) is a process that allows investors to apply for a rights issue while keeping the application amount blocked in their bank accounts. The funds are only debited once the allotment of shares is confirmed, making ASBA a secure method of applying for the right issues in India.

SEPC Rights Issue

A SEPC Rights Issue is an offering made by the Securities and Exchange Board of India (SEBI) for companies operating under the Special Economic Zones (SEZs) to raise capital. These companies may offer the right issues to existing shareholders to finance their operations or expansion plans.

Bonus Issue vs Rights Issue

A bonus issue is when a company issues free shares to its existing shareholders based on the number of shares they currently hold, usually to distribute profits or reserves. In contrast, a right issue requires shareholders to purchase additional shares at a discounted price, usually to raise capital for the company’s activities.

How to Buy Rights Issue Shares

To buy shares in a right issue, investors need to exercise their right to subscribe during the application period. Shareholders can either:

• Apply through ASBA: Block the application amount in their bank account.
• Apply via the Rights Issue Application Form: Submit the form and make the payment to apply for additional shares.

Rights Issue Example

Suppose a company offers a 1:5 right issue, meaning shareholders can buy 1 additional share for every 5 shares they own. If the market price of the stock is ₹100 and the right issue price is ₹80, the investor can buy 100 shares for ₹8,000 instead of ₹10,000 at the market price.

You may also want to know the Lock-in Period

Benefits of a Rights Issue

1. Capital Raising: A right issue allows a company to raise funds directly from its existing shareholders, which helps avoid external debt or new investors taking a controlling stake.
2. No Ownership Dilution for Current Shareholders: Shareholders have the option to buy new shares in proportion to their existing holdings, ensuring their ownership percentage remains intact if they choose to participate.
3. Discounted Shares: The discounted price makes the right issue attractive to shareholders, as they can purchase shares below the current market price, which may lead to a short-term capital gain if the stock price recovers after the issue.
4. Increased Liquidity: The company can use the money raised through the rights issue for expansion, reducing debt, or improving operations, which may boost profitability and drive stock prices higher.

Risks Associated with a Rights Issue

1. Dilution of Share Value: If shareholders do not participate in the right issue, their percentage of ownership in the company will decrease, leading to dilution of earnings per share.
2. Price Adjustment: Post-right issue, the market price may fall due to the increase in the number of outstanding shares. However, this is typically expected and factored into the discount pricing.
3. Failure to Raise Capital: If a right issue is undersubscribed (i.e., not enough shareholders participate), the company may not raise the full capital it needs, potentially impacting its plans or financial stability.

How to Participate in a Rights Issue

1. Review the Offer: The company will send out details about the right issue, including the subscription ratio, issue price, and application process.
2. Decide to Subscribe or Sell Rights: Shareholders can decide to either:
   • Subscribe to the issue and buy additional shares.
   • Sell their rights if they do not wish to participate.
3. Apply Through ASBA or Other Methods: In India, investors apply for the right issue using the ASBA mechanism, which debits their application funds only after allotting the shares.
4. Payment: Make the necessary payment to exercise the rights and buy shares at the discounted price.
5. Post-Allotment: After allocating the shares, the company credits the newly issued shares to the investor’s Demat account.

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Conclusion

A right issue is an important financial tool that companies use to raise capital, offering shareholders the opportunity to buy additional shares at a discounted price. It provides a way for investors to increase their holdings or take advantage of a discount, while companies benefit from raising funds without needing to attract new shareholders. However, participants should carefully consider the dilution of ownership and potential price adjustments post-issue. Understanding the rights issue process and its potential impact can help you make informed decisions as an investor.