A rights issue is an offering of rights to the existing shareholders of a company that gives them an opportunity to buy additional shares directly from the company at a discounted price rather than buying them in the secondary market. The number of additional shares that can be bought depends on the existing holdings of the shareowners.
Features of a Rights Issue
- Companies undertake a rights issue when they need cash for various objectives. The process allows the company to raise money without incurring underwriting fees.
- A rights issue gives preferential treatment to existing shareholders, where they are given the right (not obligation) to purchase shares at a lower price on or before a specified date.
- Existing shareholders also enjoy the right to trade with other interested market participants until the date at which the new shares can be purchased. The rights are traded in a similar way as normal equity shares.
- The number of additional shares that can be purchased by the shareholders is usually in proportion to their existing shareholding.
- Existing shareholders can also choose to ignore the rights; however, if they do not purchase additional shares, then their existing shareholding will be diluted post issue of additional shares.
Reasons for a Rights Issue
- When a company is planning an expansion of its operations, it may require a huge amount of capital. Instead of opting for debt, they may like to go for equity to avoid fixed payments of interest. To raise equity capital, a rights issue may be a faster way to achieve the objective.
- A project where debt/loan funding may not be available/suitable or expensive usually makes a company raise capital through a rights issue.
- Companies looking to improve their debt to equity ratio or looking to buy a new company may opt for funding via the same route.
- Sometimes troubled companies may issue shares to pay off debt in order to improve their financial health.