A Rights Issue of Shares is a corporate move where a company offers existing shareholders the chance to buy additional shares at a predetermined price, typically below the market value. This allows shareholders to maintain or increase their ownership stake, helping the company raise capital for various purposes without diluting ownership significantly. In this article, let's understand more about what is rights issues of shares, benefits, disadvantages, and more.
Example of a Rights Issues of Shares
Ravi holds 2000 shares of ABC Corp., each trading at Rs.20. The company then announces a rights issues in the 2-for-5 ratio, offering the new shares at a discounted Rs.5 per share.
Essentially, for every 5 existing shares at Rs.20, the company provides 2 rights shares at Rs. 5.
Ravi's Portfolio Value (pre-rights issue) = 2000 shares x Rs. 20 = Rs. 40,000
Number of right shares to receive = (2000 x 2/5) = 800
Cost to acquire rights shares = 800 shares x Rs.5 = Rs. 4000
Total shares after exercising rights issue = 2000 + 800 = 2800
Revised Portfolio Value after rights issue = Rs.40,000 + Rs.2800 = Rs.42800
Expected price per share post-rights issue = Rs.42800 / 2800 = Rs.15.28
Theoretically, the share price should be Rs.15.28 post-rights issue, yet market variations may occur. An increase benefits the investor, while a dip below Rs.15.28 results in losses.
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How Do Rights Issues of Share Work?
Here’s how the process of Rights issues of shares works:
- Company Declaration: The firm publicly announces its plan to issue additional shares, targeting existing shareholders. This strategic move is often initiated to secure funds for expansion and other capital necessities.
- Proportional Allotment: Existing shareholders are privileged to acquire extra shares in proportion to their current holdings. Each shareholder's rights allocation is typically based on their existing share count.
- Subscription Rate: The company establishes a subscription price for the new shares, usually below the prevailing market rate. This discounted rate serves as an enticement for existing shareholders to exercise their rights.
- Rights Trading: In certain instances, shareholders can trade their rights on the stock market. This allows shareholders uninterested in subscribing to sell their rights to other investors who may be keen on acquiring them.
- Exercise Window: Shareholders are granted a specific timeframe to exercise their rights and acquire new shares. If a shareholder opts not to exercise their rights within this period, the rights may expire without any value.
Why do Companies take on the Right Issues?
Companies take on the rights issues share for these reasons:
- The company might look to secure more equity capital to realign its debt-equity ratio.
- Some companies issue rights shares to raise capital for expansion. For instance, if a company wants to branch out into an untapped market or add more versatility to its existing products or services, it might need a lot of cash. Moreover, an issue of rights gives the company quick access to money.
- As a way to pay off the company's debts and boost its financial health.
- For projects or ventures that can't be financed with debt. There might be no more room for debt financing because the company has already used its optimum limit.
Benefits of Participating in Rights Issues of Shares
Rights issues of shares have several benefits for companies, but they also have some benefits for shareholders. Some of them are listed below:
- The company's shareholders can buy more stock at a discounted price. Thus, increasing their ownership stake in the company for much cheaper than the market price.
- Existing shareholders can retain control over the company without giving up their rights in favour of new shareholders.
- In rights issues, shares are offered at a discount price to instil confidence in shareholders.
- A better financial situation because the company raises more funds without taking on more debt.
Disadvantages of Rights Issues of Shares
You could have a rights issue for many reasons, but there are drawbacks. When a company is in financial trouble, a rights issue can be incredibly disadvantageous:
- When companies are strapped for cash, they raise money through rights issues, which could be a warning.
- Information about a company's cash crunch hurts its reputation and lowers its stock price.
- The company might issue more shares, which spreads the profit over more shares and hurts earnings per share (EPS).
- Rights issues may dilute the value of shares issued in the open market due to an increased supply.
- When a company issues a rights issue, shareholders might see it as a sign of trouble and sell their shares, which could lower the stock price.
- There may be few takers for rights issues when a company's growth rate is slow.
So, after understanding what are the rights issues definition, advantages, and disadvantages, let's examine who is eligible for rights issues.
Are Rights Issues Suitable for All Investors?
To expand their operations, companies often issue rights issues. Since the funds raised by the company are used to expand, taking part in a rights issue may potentially pay off later on. However, an investor can only participate in a rights issue if they meet the eligibility criteria. Here’s the eligibility:
Shareholders receive rights issues proportionally to the number of shares they already own. Nevertheless, the shareholder must possess these stocks before the ex-date and record date.
Rights issues of shares allow companies to raise capital from existing shareholders by offering additional shares at a discounted price. This enables shareholders to increase ownership stakes and participate in the company's growth and expansion plans. While participating in a rights issue provides benefits such as discounted stock prices and improved financial situations, there are potential drawbacks, including negative impacts on stock prices.
Moreover, apps like the BlinkX share market app can provide real-time data and insights to assist investors in navigating the share market and making informed investment decisions.
FAQs on Rights Issues of Shares
Yes, there is a capital gains tax on the purchase and sale of rights shares. It is common for gains from selling rights shares to be taxable, and shareholders should be aware of the potential tax repercussions.
Yes. The share price can be affected by rights issues by diluting its value and reducing trading volumes. Introducing more shares can reduce the stock price and lead to a downward trend in valuation.
If the company experiences slower growth, current shareholders may not want to purchase more shares. When a company issues rights, the market may interpret it as a sign of trouble.
No. In a rights issue, the shareholder receives rights but is not obligated to purchase additional shares.
The rights issue allows existing shareholders to purchase additional company shares at a reduced price within a specific period. An IPO offers shares to the general public, whereas a rights issue is only available to existing shareholders.