Sharekhan Blog

Understanding the Right Issues of Shares

  • Mar 11, 2024

This method allows existing shareholders to purchase additional shares at a set price, allowing them to increase their investment while also enabling the company to raise much-needed funds.

The process of the right issue of shares is complex and involves several steps and considerations. Companies must determine the number of shares to issue, the price at which they will be sold, and how the proceeds will be utilized. Additionally, existing shareholders must decide whether to exercise their right to purchase additional shares.

The implications of the right issue of shares can be significant for the company and its shareholders. On the one hand, the company can raise fresh capital without relying on external investors, which can be an advantage in certain situations. On the other hand, existing shareholders may be wary of a rights issue as it can dilute the value of their existing shares. Therefore, careful consideration and analysis are necessary before embarking on a rights issue of shares.

Definition and Purpose

A rights issue, also known as a rights offering, is a fundraising technique used by companies to issue additional shares of stock to their current shareholders. This means the company gives its existing shareholders the chance to purchase more shares at a discounted price compared to the current market value. By doing this, shareholders can increase their stake in the company and benefit from its future growth potential.

A right issue is a common method corporations use to raise funds for various purposes, such as financing expansion plans, paying off debts, or funding essential business activities. Essentially, a rights issue allows current shareholders to purchase additional shares of the corporation's stock at a discounted price. This enables the corporation to raise capital without taking on more debt or diluting the ownership of existing shareholders. By offering shares to current shareholders first, a rights issue allows them to maintain their ownership percentage in the company while also supporting its growth and development.

The number of shares offered to each shareholder is based on their current shareholding, which helps maintain the relative ownership positions of the shareholders. Overall, a rights issue is cost-effective for companies to raise capital while strengthening their relationship with existing shareholders.

Mechanics of Rights Issues

The mechanics of rights issues involve several key steps:

 1. Announcement:

   - The company announces its intention to issue additional shares to existing shareholders.

 2. Ratio Determination:

   - The company decides the ratio at which new shares will be offered to existing shareholders. This ratio typically determines how many new shares a shareholder can buy for every share they currently own.

 3. Subscription Price:

   - The subscription price, at which existing shareholders can buy new shares, is determined. It is often set at a discount to the current market price to incentivize participation.

 5. Trading Rights:

   - Shareholders receive entitlements to rights, representing the option to purchase new shares. These rights are tradable and can be bought or sold in the market.

 6. Subscription Period:

   - Shareholders are given a specific period to exercise their rights by purchasing additional shares.

 7. Proceeds Utilization:

   - Once the subscription period concludes, the company utilizes the proceeds from the rights issue per its stated objectives.

Implications for Shareholders

 1. Dilution:

   - Rights issues can dilute existing shareholders' ownership stake since new shares are issued, increasing the total number of outstanding shares.

 2. Investment Decision:

   - Existing shareholders must decide whether to exercise their rights by purchasing or expiring additional shares. This decision depends on factors such as the company's financial health, growth prospects, and the attractiveness of the subscription price.

 3. Trading Rights:

   - Shareholders can sell their rights entitlements in the market if they do not wish to subscribe to additional shares. This provides flexibility and liquidity to shareholders.

Benefits for Companies

 1. Capital Infusion:

   - Rights issues allow companies to raise capital quickly without relying on external investors or incurring debt.

 2. Retention of Control:

   - By offering shares to existing shareholders, companies can maintain their current ownership structure and prevent dilution of control.

 3. Cost-Effective:

   - Rights issues are often more cost-effective than other capital-raising methods, such as public offerings, as they involve fewer regulatory hurdles and underwriting fees.

Challenges and Considerations

 1. Shareholder Participation:

   - Companies may need help ensuring full participation from existing shareholders, especially if market conditions are unfavourable or shareholders are unwilling or unable to invest additional capital.

 2. Regulatory Compliance:

   - Companies must adhere to regulatory requirements and obtain necessary approvals before proceeding with a rights issue.

Conclusion

Rights issues of shares are a fundamental mechanism for companies to raise capital while allowing existing shareholders to participate in the company's growth. Understanding the dynamics and implications of rights issues is crucial for companies and shareholders to make investment decisions and navigate the complexities of corporate finance effectively.

Team Sharekhan
by Team Sharekhan

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