A rights issue is an issue of rights to buy additional securities in a company made to the company’s existing security holders. When the rights are for equity securities, such as shares, in a public company, it is a way to raise capital under a seasoned equity offering. Rights issues are sometimes carried out as a shelf offering. With the issued rights, existing security holders have the privilege to buy a specified number of new securities from the firm at a specified price within a specified time. In a public company, a rights issue is a form of public offering (different from most other types of public offering, where shares are issued to the general public).
Also, Read: Company – Definition and its features
Rights issues may be particularly useful for closed-end companies, which cannot retain earnings because they distribute essentially all of their realized income and capital gains each year; therefore, they raise additional capital through rights offerings. As equity issues are generally preferable to debt issues from the company’s viewpoint, companies usually opt for a rights issue when they have problems raising equity capital from the general public and choose to ask their existing shareholders to buy more shares.
A rights issue is directly offered to all shareholders of record or through broker-dealers of record and may be exercised in full or partially. Subscription rights may either be transferable, allowing the subscription rights holder to sell them privately, on the open market or not at all. A rights issue to shareholders is generally made as a tax-free dividend on a ratio basis. Because the company receives shareholders’ money in exchange for shares, a rights issue is a source of capital in an organization.
An issue of rights to a company’s existing shareholders that entitles them to buy additional shares directly from the company in proportion to their existing holdings, within a fixed time period. In a rights offering, the subscription price at which each share may be purchased in generally at a discount to the current market price. Rights are often transferable, allowing the holder to sell them on the open market.
Companies typically issue rights to give their existing shareholders the opportunity to buy additional shares before other buyers, and also to enable current shareholders to maintain their proportionate stake in the company.
A company will offer more shares to its shareholders to raise extra money for the company. Companies with a poor cash flow will often use a rights issue to increase cash flow and pay off existing debts. Rights issues, however, are sometimes issued by companies with healthy balance sheets in order to fund research and development projects or to purchase new companies.
Discounted shares issued by a company can be tempting but it is important to find out first the reason for the rights issue of shares. A company, for example, may be using the rights issue as a quick cash fix to pay off debts masking the real reason for the company’s cash flow failing such as bad leadership. Caution is advised when offered with a rights issue.
Issue rights the financial manager has to consider:
- Engaging a Dealer-Manager or Broker Dealer to manage the Offering processes
- Selling Group and broker-dealer participation
- Subscription price per new share
- Number of new shares to be sold
- The value of rights vs. trading price of the subscription rights
- The effect of rights on the value of the current share
- The effect of rights to shareholders of record and new shareholders and rights holders
New stock (share) issue offered to existing stockholders (shareholders) in proportion to their current stock/shareholding, for a specified period and at a specified (usually discounted) price. Its objective is to afford them the opportunity to maintain their percentage of ownership of the firm.