Rights issue is a very common term in relation to stocks and is a very effective tool used by corporations. It is a way for the corporates to raise additional capital for various purposes like the expansion of the business, acquiring a new asset or plant, business diversification, paying off long-term debts, etc.
What is Rights issue?
When a company issues rights shares it is essentially the issue of additional shares for the existing shareholders. Such shareholders get the ‘right’ to subscribe to the additional capital issued by the company under the rights issue. Therefore, the rights issue is not mandatory for the shareholders to subscribe.
The company issues the rights shares at a discount than the current market price of such shares. This creates an advantage for the existing shareholders as they can get additional shares of the company at a reduced price. The overall cost of investment thus reduces for the existing shareholders.
Companies issue rights shares in a fixed ratio that is predetermined before the declaration of the rights issue. For example, if the company declares a rights issue in the ratio of 15:1, it implies that for every 15 shares held by the shareholder they will get the right to buy 1 rights share.
Rights issues are an easier option for raising share capital rather than raising share capital through a Follow-on Public Offer. The latter requires the companies to follow many rules and regulations laid down by SEBI in this regard whereas, the same for rights issues are less stringent.
The idea or the notion behind this is that as the shares are offered to existing shareholders, they have a fair idea about the company’s business, its practices, and other relevant factors like the management of the company. Therefore, companies in need of excess capital can raise it through a rights issue easily. The cost of raising funds through a rights issue is also lower as compared to other means of raising capital. Some companies may also raise share capital through the rights issue as they may not be eligible to get the required amount of borrowed funds through traditional lending options.
A rights issue is also beneficial from the promotor’s point of view as it does not change their shareholding pattern. The promoters usually subscribe to all the stocks offered to them under the rights issue as well as the unsubscribed portion of the rights issue.
What are the advantages of a rights issue?
There are several advantages of issuing a rights issue. Some of such advantages are discussed below.
- The prime benefit of the rights issue is getting additional quality stocks at a lower cost.
- Shareholders can retain their control over the company by subscribing to new capital without the risk of diluting their share.
- Shareholders get renewed confidence in the company and its performance when they are offered additional shares at a lower rate.
- The company can get additional funds at lower costs and without the burden of excess debt which can help in improving the financial health of the company in the long run.
What are the limitations of a rights issue?
Some of the common disadvantages of a rights issue are highlighted hereunder.
- The issue of rights shares is to fulfill the capital needs of the company. If these shares are not subscribed fully or at the bare minimum to fulfill the capital needs, the purpose of the rights issue is not served.
- A rights issue by any reputed company could sometimes be perceived negatively. Investors may perceive the company to have limited sources of finance due to which the company has turned to the rights issue.
- Shareholders who do not subscribe to the rights issue will face a reduction of their shareholding
- The EPS of the company will take a hit on account of the rights issue.
- Companies having a slow growth rate and a matured product may not get enough shareholders for subscription.
What are rights entitlements (REs)?
Rights Entitlement (REs) are a relatively new concept in the Indian share markets. The company issuing rights shares issues Rights Entitlements to the credit of the eligible shareholders in the Demat account. REs are issued in the same ratio as the rights shares. After receiving the REs, the eligible shareholders can use them for any of the following actions,
- Buy the rights shares using the REs to the full extent, part extent (with or without renouncing the balance REs), or in excess of their REs
- Sell the REs to other interested parties who wish to buy the rights shares (shares of the company at a discounted price).
- Leave it in the Demat account and take no action. In such an event, at the expiration of the REs, the chance to buy or sell the rights shares will be lost as well.
Hence, it is important for the eligible shareholders to decide the necessary action before the expiry of the REs and take necessary steps in that regard.
The application process for rights shares involves a lot of steps. This process is highlighted below.
- Send the notice for a Board meeting. Such notice has to be sent at least 7 days prior to the Board meeting with the agenda for the meeting to be included.
- The next step is to convene the meeting and then pass a Board resolution approving the issue of rights shares. The approval of shareholders is not necessary for the rights issue.
- The next step is the issue of a ‘Letter of Offer’ to the eligible shareholders. The maximum time for the shareholders to act on such a letter is 30 days.
- If the shareholders choose to exercise their rights issue then they have to send the acceptance application along with the minimum application money.
- The Board will issue notice for a follow-up meeting or a second meeting to prepare the list of shareholders for the final allotment of shares.
- Such allotment has to be completed within 60 days of receiving the application money.
- The company is then required to file Form PAS -3 with the Registrar of Companies, within 30 days from the allotment of the shares.
- The final step is the issue of share certificates to the approved list of allottees.
Rights issues are an excellent option for the companies to raise additional capital with lower compliances. They are also a good option for the existing shareholders to buy additional shares at a discounted price than the current market prices. This reduces the overall cost of investment and will eventually help in increasing the potential net returns.
The value of the REs or the rights issue is the difference between the current market price of the shares and the price at which the rights shares are offered.
Company can issue two types of rights shares based on the payment terms namely, fully paid rights shares and partly paid rights shares.
There are two types of rights issues based on their transferability as mentioned below.
-Renounceable rights shares where the eligible shareholders can sell their rights in the open market if they do not wish to subscribe for the same.
-Non-renounceable rights shares where the option to sell the rights is not available to the eligible shareholders. Such rights can either be subscribed by the eligible shareholders or they will have lapsed upon their expiry.
The process to apply for rights shares is,
-Online application through ASBA (Application Supported by Blocked Amount) similar to subscribing to an IPO.
-Offline application by receiving a courier of Composite Application Form (CAF) from RTA (Registrar and Transfer Agent) of the Company.