A rights issue is a process by which a company invites its existing shareholders to buy more shares in proportion to their shareholdings. The company sells rights shares at a discount to the current market price. The article explains everything about the rights issue of shares, how it works, why companies offer rights shares, what rights entitlement is, what benefits they offer the company and shareholders and how to apply for rights shares online.
Before we continue, let’s understand the meaning of the rights issue.
Rights issue meaning
When a company issues new shares to its existing shareholders, this is referred to as a rights issue. Rights shares are offered at a discount to the current market price. Shareholders can purchase rights shares proportionately to their existing shareholding or the number of shares they hold.
The company is offering the rights issue to existing shareholders, which will help the company to raise the required capital without attracting new investors.
Rights issue of shares by a growing company offers investors the opportunity to buy more shares directly from the company at a lower price than the market price. However, they are not obliged to apply for rights shares. Those who do not wish to buy more shares can transfer rights entitlement to another shareholder or let them lapse.
Example of Rights Issue
Let’s understand rights issue with an example.
A company ABC Ltd offers rights shares in a ratio of 1:4 and the rights issue price is fixed at Rs 20 per share. The current market price per share is Rs 25.
Rights Issue 1:4 means 1 rights share is offered for every 4 shares held by an investor.
An investor owns 200 shares of the company at Rs 25 per share.
Current Investment Value = 200 shares * 25/per share
= Rs 5,000
Rights Issue Entitlement
= 200*1/4 = 50 shares
Thus, investor is eligible to purchase 50 rights shares from the company.
Cost of rights shares
= 50 shares * 20 per share price
= Rs 1,000
Total Investment value after purchasing rights issue
= Rs 5,000 + Rs 1,000
= RS 6,000
Cost per share after rights issue
= Rs 6,000/250
= Rs 24 per share
All in all, applying for more shares at a price lower than the current share price in market helps shareholder to decrease the cost of holding each share. However, if the market price after rights share is higher than Rs 24, it will benefit investor while if it falls below Rs 24, investor will be in loss.
Features of Rights Issue of Shares
- A company may issue rights shares when it needs additional capital for various purposes, be it business expansion, buying new machinery, working capital requirements, paying off its debts or other purposes. By issuing rights shares, a company can raise the necessary funds without incurring underwriting fees.
- Rights shares are offered at a discounted price than the current market price of the company’s shares. The discount offered is an incentive for current shareholders that encourage them to subscribe for more shares.
- The issue of rights shares is offered in proportion to the total number of shares held by the shareholders. Existing shareholders may purchase rights shares in proportion to their current shareholding.
- Shareholders who have shares of the company in their demat account on the record date are eligible to participate in the rights offer.
- The rights issue in the share market gives existing shareholders of the company the right, but not the obligation, to acquire more shares.
- Shareholders who are not interested in acquiring more shares can choose to forego their rights entitlement.
Why do companies issue rights shares?
There can be several reasons behind rights issue of shares. Some important reasons for issuing rights shares are described below;
- Capital Expenditure: A company may announce rights issue to raise capital for different purposes such as expansion of the business, purchase of new equipment, investment in new machinery, R&D initiatives, etc.
- Repayment of debt capital: A company must pay interest on the debt capital. Therefore, a company can use the funds raised through a rights issue to repay its existing debt. This helps the company to reduce its interest burden and improve its credit rating.
- Balance capital structure: Companies that want to manage their debt-to-equity ratio can also follow this route and repay a portion of their debt or loans. This helps companies reduce over-reliance on debt for long-term financing.
- Meeting working capital requirements: Every business needs adequate working capital to carry out its day-to-day business activities. A company that does not have sufficient liquid capital can issue rights shares to raise the required working capital for the company.
- Shareholder dilution management: As the new rights shares are offered to existing shareholders, the impact of dilution can be better managed. Shareholders participating in the rights issue will be able to maintain their pro-rata shareholding in the company.
Rights Issue: How does it work?
Let’s look at the process of how a rights issue work in share market;
- Rights issue announcement: First, a company will make an announcement for the rights issue to existing shareholders on the stock market.
- Record date: The record date is set by the issuing company. The record date in a rights issue is the date on which the shares of the company must be available in your demat account to be an eligible shareholder to be entitled to the rights issue.
- Proportional allotment: The company determines the eligibility for rights issue, i.e. the proportionate allotment of rights issue. Each eligible shareholder can apply for the rights shares in proportionate to the number of shares held in his demat account on the record date.
Suppose a company issues rights shares in the ratio of 1:6 i.e. a shareholder holding 6 shares can apply for 1 rights share, a shareholder holding 12 shares can subscribe for 2 rights shares.
- Price of the rights shares: The issuer company sets the price of the rights shares, which is usually lower than the market price of the share, to incentivize existing shareholders.
- Open for subscription: There is a fixed period during which the rights issue is open for subscription. Existing shareholders may or may not choose to subscribe to the rights issue; if they do not exercise their rights during the subscription period, they will lapse.
Rights Entitlement
Earlier you had to submit physical forms to apply for entitlements, but now with Rights Entitlement, one can purchase rights shares online.
Rights Entitlements or RE represents shareholder to apply for the rights shares. Under Rights Entitlement, the Registrar and Transfer Agent (RTA) of the rights issue credits the rights shares to the demat account of all eligible shareholders. RE is offered in proportion to the number of securities currently held by a shareholder.
These are temporary securities. Shareholders have the option of applying for the rights offered or selling them on the market. Subscription rights are traded on the secondary market just like shares.
If you do not own shares in the company on the record date, you are not an eligible shareholder for the subscription rights. However, you have the option of purchasing RE in the secondary market. In this way, you can not only subscribe to the subscription rights on offer, but also purchase them at a lower price.
Rights issue Benefits to the Company
A company that raises capital through rights issue of shares offering enjoys several advantages. Here is the list;
- Direct access to required capital: Offering more shares to the existing investors provides a quick way to raise money. A promising company with strong growth outlook will be able to quickly raise capital by the rights offering of shares. The company can utilize the generated capital from rights issue for various objectives such as financing its expansion plan, reduce its debt capital, finance R&D activities, etc.
When most of the shareholders participate in the rights offer, it develops a sense of shareholder’s trust in the company’s growth trajectory.
- Cost-effective route to raise funds: Rights issue of shares is a cost-effective means of raising funds because unlike IPO where company needs to pay underwriting fees, rights issue eliminates such expenditures.
- Maintain dilution: As existing shareholders get preferential rights to buy rights shares, it helps the company to manage equity dilution.
Rights issue Benefits to the Shareholders
Existing shareholders of the company will enjoy various benefits by applying for the rights shares;
- Increase shareholding: The rights issue of shares by a company provides an exclusive opportunity to investors to participate in the rights offer. Company’s current shareholders by subscribing to the rights shares can increase its shareholdings.
- Purchase rights shares at a discounted price: Another important benefits is company’s existing investors have the rights to acquire more shares at a reduced price than current market price. It helps investors to reduce their overall cost of holdings per share.
- Maintain proportionate holdings: Rights shares are offered proportional to the shareholder’s current holdings. Thus, Shareholders who participate in the offer, their proportionate holdings before and after the rights offer remains unaffected.
- Sale of rights entitlement: People who do not want to exercise their rights entitlement, can sale them on the exchange. RE are bought and sold in the secondary market.
Rights Issue Apply Online
Can I apply for rights issues online? Yes!
1. ASBA Net Banking Process
Most banks in India, including HDFC, ICICI, SBI Axis, Kotak Mahindra, etc. offer ASBA services to their customers to apply for rights issues online. Eligible shareholders who wish to submit applications for the rights shares can use their bank’s net banking portal. The process for applying for a rights offering is similar to applying for an IPO.
Let’s check out how to apply for rights issues online.
- Log in to your internet banking account.
- Search for the IPO/FPO/Rights Issues/Buyback option.
- List of current rights issue (RI) will be displayed.
- Select the one of your choice.
- Enter your Demat account details such as CDSL or NSDL, and your Demat account number.
- Fill in the number of rights shares you want to apply for.
- Accept the terms & conditions.
- Place the order and it will be visible in the order book.
2. Via Registrar and Transfer Agent (RTA)
In India, KFin Technologies and CAMS are the RTAs. One can submit rights issue applications via RTA also. Here is the process explained;
- Visit the RTA’s website.
- Click on Apply for rights issue option.
- Fill in your PAN number and DP account details.
- Enter the quantity or number of rights shares you want to subscribe for.
- Select the mode of payment and make payment.
- Upon successful payment, you will receive an email about your applications for the rights issue has been successfully placed.
- You will get rights shares in your Demat account.
End Note
A rights issue is a good way for the company to raise money from existing shareholders without diluting shareholders' rights, while giving shareholders the opportunity to get more shares at a lower price.
However, not all rights issues are beneficial. If the company is low on cash and desperate to raise capital through the rights issue, applying for such a rights offer may not be a good decision. Before subscribing for rights shares, you need to be careful, research thoroughly and check the fundamentals of the company to make a wise decision.
