What is a Rights Issue?

A rights issue is a corporate action through which companies raise additional capital by offering existing shareholders the opportunity to purchase new shares at a discounted price. These shares are offered at a price lower than the prevailing market price, giving shareholders a cost-effective way to increase their ownership in the company. Participation in a rights issue is voluntary, and shareholders can choose to subscribe partially, fully, or not at all, based on their investment goals.

Rights issues are often used to fund expansion, improve the company’s debt-to-equity ratio, or repay existing debt. Shareholders can also trade their rights entitlement (if permitted) in the market, allowing others to subscribe to the issue instead.

Why do Companies Offer Rights Issues to Their Shareholders?

A rights issue is a strategic method for companies to raise additional capital. The funds raised can serve multiple purposes, including:

1. Companies often use rights issues to expand their operations, launch new products, or enter new markets.
2. By raising equity capital instead of taking on more debt, companies can strengthen their financial stability and reduce interest costs.
3. Rights issue proceeds can be used to repay loans, leading to a healthier balance sheet and better creditworthiness.
4. Companies facing temporary cash flow challenges may issue rights to raise funds quickly without increasing their debt obligations.

When Should an Investor Participate in a Rights Issue?

Investors should consider participating in a rights issue under the following conditions:

1. Company Expansion: If the funds are allocated to growth-oriented projects, participating may yield long-term rewards.
2. Eligibility: Shareholders holding shares before the ex-date qualify for the rights issue. It’s important to check the record date and ensure eligibility.
3. Discounted Offer: When the offer price is significantly lower than the market price, it can be a good opportunity to invest in the company at a reduced cost.

Record date: The day on which the company assesses its records to check which shareholders qualify for the rights issue is called the record date.

Ex-date: Shares bought on or after the ex-date, a day before the record date, are not eligible for the rights issue. When you buy shares, it takes T+2 days for the stock exchange to settle the transaction. So, shares that are bought on the ex-date or after will not reflect in your account on the record date, making you ineligible for the rights issue.

How Does a Rights Issue Work?

1. The company announces the offer, detailing the ratio of new shares to existing shares, the offer price, and the record date.
2. Shareholders eligible as of the record date can subscribe fully, partially, or not at all.
3. If permitted, shareholders can also sell their rights entitlement in the secondary market to other investors.
4. After the subscription period ends, the new shares are allotted and credited to shareholders’ demat accounts, while the funds raised are utilised for the stated purpose

Features of a Rights Issue

1. Rights issues are offered exclusively to existing shareholders, ensuring they get the first opportunity to purchase additional shares.
2. Rights shares are offered in a fixed ratio to the shares already held. For example, in a 1:5 rights issue, shareholders can purchase one new share for every five shares they own.
3. The rights shares are typically priced lower than the current market price, making them an attractive investment.
4. Shareholders can decide whether to subscribe to the rights issue, subscribe partially, or let the offer lapse.
5. In many cases, shareholders can trade their rights entitlement on the stock exchange, providing flexibility to those who choose not to participate.
6. Only shareholders holding shares before the ex-date are eligible. Shares bought on or after the ex-date are not entitled to the rights issue as the settlement would occur after the record date.
7. A rights issue raises funds without increasing debt, improving the company’s debt-to-equity ratio.
8. Issuing additional shares increases the total share count, potentially diluting earnings per share (EPS) and voting power for non-participating shareholders.

What are the Benefits of Participating in a Rights Issue?

1. Shareholders can purchase shares at a discounted price, increasing their stake in the company.
2. Existing shareholders can maintain their ownership percentage and voting rights by subscribing to the issue.
3. A successful rights issue can reduce debt levels and improve financial health, benefiting shareholders in the long run.
4. Offering shares at a discount may signal confidence in the company’s future prospects.

Example of a Rights Issue

A prominent example is Reliance Industries Limited’s rights issue in 2020, which was India’s largest-ever rights issue. Reliance offered one new share for every 15 shares held at a discounted price of ₹1,257 per share, raising ₹53,125 crores. The funds helped Reliance achieve debt-free status ahead of schedule, and shareholders who participated benefited from the company’s growth trajectory.

What are the Disadvantages of a Rights Issue?

1. The increase in the number of shares reduces earnings per share if the raised funds do not generate proportional profits.
2. Rights issues by financially distressed companies may be seen as a sign of weakness, impacting share prices negatively.
3. Shareholders who do not participate may see their ownership percentage and voting power reduced.
4. An increase in share supply can lead to a drop in share value, especially if investor sentiment is weak.

Conclusion

A rights issue provides existing shareholders with a chance to increase their stake in the company at a discounted price while enabling the company to raise funds for growth or debt repayment. However, it introduces additional shares into the market, which may dilute share value and earnings per share.

Investors should conduct thorough due diligence, analysing the purpose of the rights issue and the company’s financial health, before deciding to participate. For well-managed companies with clear growth plans, a rights issue can be a valuable investment opportunity.

FAQs