Everything You Need to Know about Rights Issue of Shares

Why do rights issues exist? Why do businesses create rights issues? Why are they restricted to current shareholders only? Before exercising their rights entitlement, what should shareholders consider? How do I request a rights issue? We explain how rights issues function and what they signify for the firm and its shareholders. When a company is seriously short on cash, it can use rights issues to obtain money. Companies provide shareholders with the option, but not the obligation, to purchase additional shares at a discount to the current market rate in these rights offerings.

Debt and equity are the two types of capital that a business can utilise to finance its operations. When a firm uses debt financing, like bank loans, bonds, debenture and external commercial borrowings, it must pay back the money it borrowed plus interest; when a company uses equity financing like rights issue, preferential allotment, follow on public offer and qualified institutional placement, stockholders are not expected to be paid back. Additionally, there are several quasi-equity structures, like convertible instruments and preference shares, that combine debt and equity.

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What is a Rights Issue?

A corporation obtains money by issuing additional shares, but exclusively to current shareholders, in a rights issue. In other words, if you possess a share, you have the “right” to purchase additional shares in a specific quantity and at a specific price. Only shareholders whose names are on the company’s shareholder register on a record date, typically a few days after shareholders approve the request to raise money through rights, are eligible to receive rights.

Section 62(1)(a) of the 2013 Companies Act governs the idea of a right issue of shares. The aforementioned section covers provisions relating to an increase in the Company’s subscribed share capital through the issuance of additional shares. Simply put, a right issue of shares is an offer to all current equity or preference shareholders of the company to receive shares in proportion to their current ownership of the company. It should be emphasised that under this model, both equity shares and preference shares may be issued, as both will increase the company’s subscribed share capital.

Shareholders may trade the rights on the market in the same manner as they would trade Common Shares until the date at which the New Shares may be purchased. The value of the rights granted to a shareholder makes up for the potential value dilution of their existing shares. Dilution happens as a result of a rights issue spreading a company’s net profit over more shares. As a result of the diluted shares caused by the allocated earnings, the company’s earnings per share, or EPS, declines.

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Reasons for Rights Issue

• If a firm seeks funds through a Follow-on public offer, it has to go through a long procedure that entails hiring merchant bankers to price the issue, offer document approval by SEBI, etc. Additionally, there are a huge amount of charges that must be paid.
• The easiest and most cost-effective way for the enterprise to generate funds is through a rights issue. The company saves a considerable sum of cash on expenses such as underwriting fees, advertisement charges, and so on that it would have expended in any other sort of fundraising.
• Why does the regulator not enforce rights as strictly? The justification is that, in contrast to selling shares to new owners, an existing shareholder already has a good insight into the company and doesn’t require the same level of inspection and disclosures.
• Additionally, unlike any other equity-based fundraising strategy, a rights issue prevents the promoter holding from diluting. Promoters typically agree to fully subscribe to both the undersubscribed portion and their portion of the rights.
• Not all businesses that explore rights issues, though, are struggling financially. Rights issues can be used by even financially sound businesses. These matters could be a strategy to raise extra money for business expansion expenses like acquisitions or the building of new production or sales facilities. Despite the dilution of the outstanding shares as a result of the rights offering, if the company uses the additional funds to finance expansion, it may eventually result in higher capital gains for shareholders. A firm will typically, but not always, have an investment bank underwrite its rights issue for peace of mind.

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Features of a Rights Issue

• Organizations implement a rights issue when they need cash for various motives. Through this method, the company can raise capital without paying underwriting fees.
• Existing shareholders receive preferential treatment in a rights issue when they are given the option (but not the obligation) to buy additional shares on or before a predetermined date for a cheaper price.
• Up until the time when new shares can be purchased, existing shareholders are also permitted to trade with other interested market players. Similar to how ordinary equity shares are exchanged, so are the rights.
• The quantity of extra shares that shareholders may purchase is often based on their current holdings.
• Existing shareholders have the option of choosing not to exercise their rights, but if they do not buy more shares, their existing shareholding will be reduced after the issuance of extra shares.

Rights Issue Eligibility

The rights issue is only accessible to current shareholders of the company, unlike the first and follow-up public offerings, which are open to the entire public. In the event of a rights issue, a firm declares a record date. One must own the company’s shares as of the record date to qualify as an existing shareholder for the rights issue. One day before the record date, the shares become ex-rights. You won’t be qualified as an existing shareholder of the corporation as of the record date if you purchase the shares on or after the ex-date, therefore you won’t be eligible to collect rights entitlements. (Taking into Account Trade Date + 2 Settlement)

Rights Issue Dates

The following table shows important events and dates when it comes to the Rights Issue.

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Rights Pricing and Ratio

The allotment is usually guaranteed, and rights bids are typically priced below market value. Existing shareholders might not be too interested if the rights are issued around the present market price. A firm chooses the ratio in which to give rights shares based on the amount of money it intends to raise and the price. The ratio ensures that each shareholder will receive a certain number of shares. One may, however, also apply for additional shares. Additionally, for a certain amount of time, these Rights themselves are tradable, enabling current shareholders to resell them to other investors on the exchange.

Shareholding Factor

When a corporation issues more shares, future Returns on Equity and EPS (Earnings per Share) will be diluted. The shareholding of any investor does not diminish, however, if the rights offer is completely exercised. If the shareholder decides not to take advantage of the rights offer, his ownership stake in the company would decrease (since others will buy and their shareholding goes up). Applying for more shares than your rights allows you to buy more if a few investors decide not to subscribe, either because they disregarded or missed the announcements, or because they don’t want to.

What is Rights Entitlement?

This is a very recent development in the Indian stock market, where the entitlement itself is traded. When a firm launches a rights issue, it issues Rights Entitlement (RE) to shareholders. The shareholders as of the record date receive REs as part of the rights issue in the same ratio. You relinquish your rights to someone else when you trade a RE. The option to purchase shares is granted to the RE buyer. Having RE shares does not guarantee that you have the right shares. A shareholder must submit an application for rights shares based on entitlements acquired separately. If a rights holder does not want to purchase further shares of the same firm, RE is a temporary credit of shares in the Demat account that enables them to sell their RE shares to other willing buyers for a fee during a trading window on exchanges. Before this, shareholders who didn’t want to apply had to let their RE expire. The buyer and seller both needed to sign documents for the renunciation process, which was complicated. The exchange process, however, makes things much simpler because all it takes is a single click on your broker’s platform to sell something. Shareholders can obtain some value from their RE shares by issuing RE shares. The difference between the stock’s then-market price and the price offered for the rights issue is used to compute the rights entitlements price. Following the establishment of the base price, pricing will fluctuate depending on the market mood, RE supply and demand, and other factors.

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Types of Rights Issue

When categorised on the terms of payment of an issue, the rights issue is divided into two.

1. Fully paid rights issue

An applicant must pay the entire issue amount at the time of application in a fully paid rights issue.

2. Partly paid rights issue

A partly paid rights issue is one in which the application fee is only partially due at that time. As and when the business places additional calls, the remaining balance is due.

Another way in which rights issues are categorised is as follows.

• Renounceable rights issue

An open market transfer or sale of a renounceable rights issue to other investors is simple. If a RE holder decides he does not wish to subscribe to his rights, he may choose to transfer them.

• Non-renounceable rights issue

A non-renounceable rights problem may not be sold or assigned to any other party. The only option available to a RE holder in such circumstances is to waive his rights and allow the RE to expire if he is unwilling to use his right to purchase the rights share.

How Rights Issues Work?

A right issue is a proposal to enhance a shareholder’s ownership in the company, which the shareholder may accept or reject and may do so by selecting one of the following:

• Apply for the eligible rights share and fully use your right.
• Completely exercising the right and requesting both the qualified rights share and any additional rights shares
• Let the rights expire and completely disregard the RE. In this instance, nothing needs to be done.
• Exercise only a portion of your rights, then let the rest expire.
• Exercise a portion of your rights, then assign the remainder to other interested investors. Renunciation of rights is the term used to describe this transfer or sale of real estate.
• To other interested investors, transfer or sell the entire RE.

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Rights Issue Procedure

Previously, it took a corporation two months to accomplish the entire rights issue, which was a lengthy process. By shortening the duration for numerous stages and implementing the dematerialization of RE, SEBI has published new guidelines in January 2020 that aim to streamline the rights issue process and lower the timeframe for completion to 31 days. Process Steps for a Rights Issue are as shown below.

• application forms are sent out or uploaded to the issuer’s, registrar’s, and exchanges’ websites.
• the credit of RE in qualifying shareholders’ Demat accounts.
• To apply for rights issues, interested investors or renouncees must complete the application form.
• Following the reconciliation of the RE Demat holding list and received applications, the allocation and credit of rights issue shares in the Demat account.

Advantages of Rights Issue

The corporation and the shareholder both gain from the rights issue in different ways.

Disadvantages of Rights Issue

• The value of the existing owners’ shares would be diluted as a result of the rights issue.
• The need for funds due to the company’s financial difficulties is one of the reasons it is considering issuing rights shares. This may occasionally send the wrong message to investors that a firm is struggling, which may affect the company’s reputation and share price.
• The rights issue would increase a company’s share count, distributing profits across a larger number of shares and lowering earnings per share (EPS).

How to Apply for Rights Issue?

The ASBA facility or R-WAP (Registrar’s Web-based Application Platform) facility are two ways that interested investors can apply for the rights issuance. To speed up the application procedure during these epidemic times, SEBI has launched the R-WAP service as a temporary solution.

Applying by ASBA Process

Investors must physically or electronically submit the application form they obtained from the issuing firm to SCSB by downloading it from the website of SCSB, the registrar, the exchange, or the company. Investors can also apply on plain paper in the worst-case scenario of the application form not being accessible. However, doing so would prevent investors from giving up their RE. Investors must have an ASBA-enabled bank account with an SCSB to apply using this mode.

Applying by R-WAP Process

The online application form is available on R-WAP, and investors must finish it. Investors must have a UPI facility enabled or an active internet banking account to apply using this technique. The R-WAP facility is exclusively available to resident investors. It is not recommended to use a third-party account to pay for applications completed through R-WAP. To avoid any problems, make sure the application form contains the correct PAN, depository, beneficiary, and bank information (ASBA or UPI). Applications submitted through the R-WAP facility cannot be submitted on plain paper.

Impact of Rights Issue on Share Price

Due to a rise in the number of shares floating in the market, when a firm provides the right issue, its share price is diluted and is likely to decline after the issue. Theoretical ex-rights price is the name given to the price that can be theoretically determined using the mathematical procedure (TERP). It is crucial to keep in mind that this is only an estimate of the share price following the conclusion of the rights issue and may vary from the real market price depending on the preference of the market. If the company is using the proceeds for expansion and investors believe the company has bright prospects, the price decline may be transient and even make a U-turn.

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Upcoming Right Issues

Below given is the table of upcoming right issues.

Applying to a rights issue has become simpler with the dematerialization of RE and the online application of rights issues. An investor can easily enter and leave the rights issue process at any moment at a price calculated from the market thanks to the listing of RE and partially paid shares. The prospective gains from purchasing or exercising a rights issue are dependent on the underlying company’s ability to make profits beyond its cost of capital. The chance to purchase shares at a discount through a rights issue may tempt investors. You might not always be receiving a good deal, though. Before accepting or rejecting a rights issue, you need to be aware of the ex-rights share price as well as the intended use of the additional cash. Make sure to find a strong justification for the need for the rights issue and share dilution in the company’s strategic plan. A rights issue can provide a temporary cure for a weak balance sheet, but that does not guarantee that management will address the underlying issues. Shareholders need to exercise caution. An investor must perceive the goal of additional investment and take into account potential future growth. There may occasionally be a strong cause to exit a business despite its promising growth potential. Download the Entri app to get more information and notes on the topics that come under the banking awareness and professional knowledge section of bank exams.