Rights issue definition

What is a rights issue?

A rights issue is when a company offers its existing shareholders the chance to buy additional shares for a reduced price. Usually the discounted price will stand for a specified time frame, after which it is returned to normal.

Why do companies offer rights issues?

A company would offer a rights issue in order to raise capital. If current shareholders did choose to buy the additional shares, a company could use the funding to clear its debt obligations, acquire assets, or facilitate expansion without having to take out a loan from a bank.

Examples of a rights issue

Let’s suppose an investor already owns 100 shares of company XYZ, and the shares are currently trading at $20 each. In order to raise more money, company XYZ announces a rights issue for current investors at a price of $15 a share, which will last for 30 days.

The company also sets a conversion rate of 5 for 10, meaning that a current investor can buy 5 discounted shares for every 10 that they currently own. As a result, the investor could buy 50 more shares for $750, a discount of $250.

Pros and cons of a rights issue

Pros of a rights issue

A rights issue is an opportunity for current shareholders to increase their stake in a company, for a reduced cost. In doing so, they increase their exposure to a company’s stock– which could be good or bad, depending on a company’s profit and loss statement.

The number of new shares that an investor can buy depends on their current holdings, but it is usually proportional – with larger shareholders being able to purchase more shares than smaller shareholders.

A rights issue is also a chance for an individual to protect their investment from the eventual dilution that will come when the company issues more stock. Dilution may occur if current shareholders sell their new stocks onto other traders – although this isn’t always guaranteed during a rights issue.

Cons of a rights issue

If the issued shares are sold on the open market, their value could be diluted relative to the increased market supply.

Rights issues can also be a risk as current shareholders may not wish to buy any more shares in the company if it is experiencing slower growth. The market may interpret a rights issue as a warning sign that a company could be struggling. This might even cause investors to sell their shares, which would bring the price down. With an increased supply of shares available following a rights issue, this could be very bad news for a company’s market value.