Rights Issue of Shares – Saurabh Investments

by | Apr 12, 2021 | Finance, Investing, Stock Market | 0 comments

Rights Issue of Shares

Meaning

Rights issue is an invitation by a company to its existing shareholder to buy additional shares at discounted price rather than buying it on stock market.

It is a type of offer a company gives to its existing shareholders to increase their shareholdings. For example, an existing shareholder can buy one extra share for every four shares already held by him. The price of the new share are issued is less than the prevailing market price of the stock. Means the additional share is offered at a discounted rate.

Rights issue is done by company to encourage shareholders to subscribe for new shares. This rights are transferable, which means shareholders can later sell this shares in the open market.

Why do companies offer rights issues?

The main reason a company issue a rights offering is to raise additional capital. A company may need extra capital to run a business or to pay off debts, especially when they are unable to borrow more funds from the banks/institutions.

However a company may also need additional capital to expand its business or to take over other businesses.

Procedure of Rights Issue

Earlier the right issue was a long process taking about two to three months for a company to complete the whole process. But in January 2020, SEBI has issued new guidelines to reduce the timeframe of rights issue completion within 31 days by introducing the new RE (Right Entitlements) procedure.

{Right Entitlement (RE) is a temporary credit of shares done by the company to the eligible shareholder’s Demat account.}

Steps in Rights Issue Procedure:

1) Upload of application forms by the user, registrar, and exchanges on their website.

2) The credit of RE in shareholders Demat account.

3) Interested investors submit application form to apply for rights issue.

4) After receiving applications, RE credit that are allotted to the shareholder’s Demat account gets converted into right issue shares.

How rights issue work?

Suppose a company offers a rights issue invitation to its existing shareholder, now the shareholders have three options –

  • They can choose to purchase the additional share –

This is what a company expect from its shareholders. If more existing investors purchases shares, the company will raise more capital.

  • They can choose to ignore the offer/invitation –

Some existing investors may don’t like the idea of purchasing additional shares keeping it in mind that the company is going through financial crisis. Thus they are most likely to ignore the offer.

  • They can choose to purchase the share and later sell them off –

Many investors choose to buy the additional shares and later sell it to other investors. As a result, a shareholder can make profit on the shares right, and the company will be able to raise the additional capital.

Does a shareholder always gets benefit from purchasing a rights issue?

Many factors determine whether or not a shareholder can gain benefit from purchasing a rights share issue.

Let’s understand this with an example –

  • Suppose Sameer owns 100 shares of ₹ 500 each.

{100 x 500 = 50,000}

  • Then he bought 50 right issue shares at ₹ 400 each (20% discount).

{50 x 400 = 20,000}

  • Now Sameer has total 150 shares and his total spending is ₹ 70,000.
  • Now after the right issue, the average market price for each share would be 70,000 / 150 = ₹ 466.
  • Thus, ₹ 466 is the ex-rights price.

Why knowing the ex-rights price is important?

Because it tells us what exactly the shareholder is getting instead of what a company promised.

In the above example, the company offers 20% discount on the right issue shares, but actually, the shareholder is getting only 6.8% discount overall.

Advantages of Rights Issue

For company,

1) Fastest mode of raising capital for the company.

2) Low cost affair, as company can save money on underwriting fees and advertisement expenses.

For the Shareholder,

1) Provide an opportunity for existing investors to increase their stake in the company at a lower price than the market value.

2) It retains the control of the company to existing shareholders, instead for the outsiders.

Disadvantages of Rights Issue

1) Sometimes the right issue can decreases the value of holding of their shareholders as per the current market value of each share.

2) The main reason of issuing right shares is the urgent need of funds for running a business. This may sometimes give wrong signal to shareholders that the company is struggling for funds, which may impact the reputation and share price of the company.

Conclusion

After SEBI announced the new Right Entitlement (RE), the rights issue are gaining popularity in the market. And thus, the companies are looking to opt to right issues to raise additional capital. The shareholders should not get attracted just by the discounts on share purchase, but should also check the company’s performance and the reason behind the right issue.

Reference

Book Reference

  • Book Name :

    THE LITTLE BOOK OF VALUATION

  • Writer Name :

    Aswath Damodaran

  • Book Name :

    Portfolios of the Poor: How the World's Poor Live on $2 a Day

  • Writer Name :

    Daryl Collins , Jonathan Morduch , Stuart Rutherford and Orlanda Ruthven

Audio Book Reference

  • Book Name :

    Audio1

  • Writer Name :

    Saurabh Kamale

Submit a Comment