Concept of Rights Issue

Published by Sharekhan Education | February 15, 2021

Concept of Rights Issue

A rights issue is a corporate action by which companies can raise additional capital from existing shareholders. It is an invitation to the existing shareholders to purchase additional new shares in the company usually at a discount to the current market price. The existing shareholders have the right but not the obligation to subscribe to the newly issued share in proportion to their existing shareholdings.

For example, recently L&T Finance proposed a rights issue of shares in the ratio 17:74. It simply means the existing shareholder of L&T Finance can buy 17 shares at a discounted price for every 74 shares he already owns as of January 22, 2021. The issue opened on 1 February and closed on 15 February 2021. The Rights Issue was at a discounted price of Rs 65 per share compared to the current market price.

Purpose of Rights issue: Companies opt for the rights issue of shares to raise capital which can be used for growth and expansion of the company, for repaying debt and they can also utilize funds for expansion through inorganic route. In a rights issue the company resorts to issuing additional shares to the existing shareholders in proportion to its current shareholding. Issue of shares to public at large would bring out an imbalance in the voting rights of the existing shareholders. It is an efficient way of raising capital as there is no requirement for shareholders’ meetings. Approval from the board of directors is sufficient.

Advantages of Rights Issue:
The shares are offered to the existing shareholders at a discounted price. So it is an opportunity for the existing shareholders to increase their stake in the company at a lower price. For the company, the Rights Issue is one of the best ways to raise capital without incurring additional debt from the banks and thus saving on interest cost. The turnaround time for raising capital via this approach is comparatively short.

Disadvantages of Rights Issue:
If the rights issue is not fully subscribed by existing shareholders then the company may fail to achieve its target of raising capital. Rights issue leads to dilution of equity for existing shareholders who do not want to subscribe. Their percentage of holding gets reduced due to the issue of new shares.

If the company is unable to drive the earnings growth with the capital raised through the rights issue, it would lead to dilution of earnings of the company, affect the valuation of the company and adversely affect the stock price.

Any existing investor, before deciding on whether to subscribe to the Rights Issue or not, should be able to look beyond the discount offered on the current market price. He is paying money to get an additional share so he should subscribe to it only if he is completely sure of the company’s performance and future potential.

If the promoter of the company is taking part in the Rights Issue then it can be viewed as a positive sign.

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