Rights Issue

A rights issue represents a strategic financial decision for a company. Here, the company gives its existing shareholders a chance to buy additional shares at a discounted price. It is considered a ‘privileged subscription offer’ and has become quite popular in India’s present corporate space. Companies use it to raise additional capital from existing shareholders without having to tap into new shareholders.

A classic case that comes to mind is Reliance Industries’ April 2020 rights issue. It was the country’s largest rights offering at Rs. 53,125 crores. The company offered one new share for every 15 shares held, thus at a ratio of 1:15. The rights issue price of Rs. 1,257 per share was well below the market price of Rs. 1,408 at that time.

Such a rights issue of equity shares has distinct features. They are transferable, and shareholders can exercise their rights to buy or sell their shares to others. The issue has a definite subscription ratio. It follows a specific time window for acceptance.

This approach to raising fresh capital is useful during periods of market volatility. With it, companies can raise more funds. Also, the existing shareholders get a preference to maintain their holding in the company.

What are the Features of the Rights Issue?

Given below are the major features of rights issue –

Shares Offered at a Discounted Price – Companies that issue rights shares typically offer them at a price lower than the market value. This discounted pricing acts as an incentive for current shareholders to go for the additional shares. It gives them immediate financial benefits. Also, they get a chance to invest in the company at a lower price than new investors.

Proportional Share Allocation – The rights are distributed in proportion to the existing ownership of a shareholder. So, if Mr X owns 3% of the company, he would be eligible to buy 3% of the issued shares. This feature ensures total fairness to existing shareholders.

Flexibility in the Use of Capital Raised Via Rights Issue – The company has a big advantage in this point. It can use the proceeds of a rights issue of preference shares for different purposes. These include:

• Funding new projects,

• Growing operations,

• Decreasing debts, and

• Strengthening the balance sheet

This versatility allows the firm to sustain growth and stability.

Freedom to Trade the Additional Shares – The beneficiary shareholders can trade these additional shares in the open market. This ensures liquidity and lets them extract value from their rights issue.

Long-Term Impact on Share Prices- While the initial dilution may affect the share price, the eventual impact depends upon how effectively the funds are utilised. Companies may use the capital raised to reduce debt or invest in strategic projects. These actions have the potential to strengthen the company’s financial position over time. However, the effect on share prices is influenced by various factors, including market conditions, investor sentiments and overall performance.

Example of Rights Issue

Let’s understand the practical application of a rights issue with a hypothetical example. Suppose Alpha Corp Ltd. announces a rights issue with the following terms to raise capital for expansion:

• Rights Issue Ratio: 1:4 (This means for every 4 shares currently held by a shareholder, they are entitled to apply for 1 new share).

• Rights Issue Price: ₹50 per share (This is the discounted price at which eligible shareholders can buy the new shares).

• Current Market Price (before the issue): ₹65 per share (This is the price the stock is trading at in the open market before the rights shares are issued).

Now, let’s consider Mr Sharma, an existing shareholder who owns 80 shares of Alpha Corp Ltd.

Here is the procedure for the rights issue of shares and the calculation for Mr Sharma:

1. Determine Eligibility: Based on the 1:4 rights ratio, Mr. Sharma is eligible to apply for: (Number of shares held/Ratio Denominator)×Ratio Numerator=(80/4)×1=20 new shares.
   So, Mr Sharma receives ‘Rights Entitlements’ allowing him to subscribe to 20 new shares.
2. Options for Mr Sharma: Mr Sharma has a few choices regarding his 20 Rights Entitlements:
   1. Exercise the Rights: Pay the rights issue price (₹50 per share) for the 20 shares. Total cost = 20×₹50=₹1000.
   2. Sell the Rights: If the Rights Entitlements are renounceable and tradeable on the stock exchange (which is common for listed companies), he can sell his rights to other investors who wish to apply for the rights shares.
   3. Let the Rights Lapse: Choose to do nothing, in which case the rights expire worthless after the offer period.
3. Scenario: Mr Sharma Exercises His Rights Mr Sharma pays ₹1000 to the company to subscribe for 20 new shares. His total shareholding after the rights issue becomes: 80 original shares+20 rights shares=100 shares. His total investment in Alpha Corp is now his original investment value plus the cost of the rights shares. (Assuming original shares were bought at ₹65 market price, initial value = 80×₹65=₹5200. Total investment = ₹5200+₹1000=₹6200). His average cost per share becomes: ₹6200/100 shares=₹62 per share.

Why Do Companies Opt for a Rights Issue?

Let us now see why companies use rights issue for raising funds –

• Companies pass a resolution for the rights issue of shares primarily as a strategic funding mechanism. With it, they can raise funds while protecting the interests of existing shareholders. The trend shows that this funding route has gained prominence, especially at times of economic uncertainty.

• Rights issues serve more than one strategic goal. They offer the ideal chance to secure capital through equity while avoiding extra debt.

• Moreover, rights issues enable companies to reward loyal shareholders by selling shares at a discount to the market price. This helps strengthen shareholder relationships while ensuring capital infusion. Companies also prefer rights issues because they are faster and involve fewer regulatory requirements than follow-on public offerings.

• Importantly, this process ensures that the structure of existing ownership is maintained. The issue of shares is proportional to the existing shares, preventing equity dilution, which is a concern for promoter groups.

• A rights issue also projects management’s confidence. This happens because existing shareholders are invited to participate in growth opportunities. This mode of raising funds allows firms that need urgent capital to decrease debts or expand business. Thus, it strikes a balance between shareholder interest and company plans.

What are the Benefits of Rights Issue for Companies?

This funding mode of rights issue offers several strategic advantages for companies. They would be able to strengthen their financial position with this move. Plus, there are other advantages like-

Raise capital without incurring higher costs – Companies can secure substantial funds via rights issue. In this case, they need not incur high underwriting fees or marketing expenses typically associated with public offerings. The process is streamlined as it targets existing shareholders.

Debt reduction flexibility – The raised capital can be used to recover high-cost debt. This may improve the company’s debt-to-equity ratio and credit rating. This was demonstrated when Tata Steel raised ₹12,800 crore from the rights issue to deleverage its balance sheet.

Ownership stability – Unlike public offerings, rights issues of shares help maintain ownership patterns. At the same time, it prevents unwanted dilution of promoter holdings. As a result of this move, strategic control remains unchanged.

Market confidence signal – Successful rights issues often indicate strong shareholder confidence in management’s vision. This move can positively impact market perception.

Lower regulatory checks – Compared to other equity-raising methods, rights issues face fewer regulatory hurdles. A rights issue can be executed more quickly.

What are the Benefits of Rights Issue for Shareholders?

For shareholders wondering why and how to apply for rights issue, these offerings may present several compelling benefits.

Discounted price – Rights issue of equity shares is mostly offered at a discount below the market price. For example, Dhanlaxmi Bank was trading at Rs. 40.35 on the NSE when it announced a rights issue at Rs. 21 a share in December 2024. Existing shareholders get preference in buying it at this lower price.

Proportional ownership percentage – Exercising rights will maintain investors’ proportional ownership and voting rights in the company. This way, their stake will not be diluted. This will give you more clarity when you search for ‘how to buy rights issue of shares?’

Tradable rights – Shareholders can sell their rights to others if they choose not to exercise them. This allows other investors to purchase these rights and benefit from the opportunity to buy shares at discounted price.

Preferential access- Rights issues provide existing shareholders with preferential access to shares. This move is often seen as a way of rewarding loyalty.

Conclusion 

Now, you have a better understanding of what is a rights issue of shares. Rights issue of shares can benefit both existing shareholders and the issuing companies. If you are an investor, consider exploring rights issues as a part of your investment strategy. Also, always evaluate the company’s performance and your financial goals before making decisions.