A rights issue is an invitation to existing shareholders to buy additional new shares in the company. To be more specific, this kind of issue gives existing shareholders securities called “rights”, which give the shareholders the right to purchase new shares Forex Broker List at a discount to the market price on a stated future date. The company is giving shareholders a chance to increase their exposure to the stock at a discount price.
However, until the date at which the new shares can be purchased, the shareholders may trade the rights on the market in the same manner that they would trade ordinary shares. The rights issued to a shareholder have value, therefore compensating current shareholders for the future dilution of their existing shares’ values.
Dilution takes place because a rights offering spreads a company’s net profit over a wider number of shares. Therefore, the company’s earnings per share or EPS diminish as the allocated earnings end up in share dilution.
The Reason for Rights Offering
Companies most commonly issue a rights offering to raise additional capital. A business may need some more Finance Brokerage Stocks capital to meet its current financial obligations. Troubled companies usually use rights issues to pay down debt, especially when they find themselves unable to borrow more money.
On the flip side, not all companies that pursue rights offerings are in financial trouble. Even companies with clean balance sheets may use rights issues to raise extra acquisitions or opening new facilities for manufacturing or sales. If the company is using extra capital to fund an expansion, it can eventually lead to increased capital gains for shareholders in spite of the dilution of the outstanding shares as a result of the rights offering.
For reassurance that it will raise the finances, a company will usually but not always have its rights issue underwritten by an investment bank.
How Rights Issue Works
Let’s suppose you have 1,000 shares in company A, and each of those shares is worth $5.50. The company is currently in some financial turbulence and needs to raise some funds to cover its debt obligations. Company A, thus, decides to have a rights offering, in which it plans to raise $30 million by issuing 10 million shares to existing investors at a price of $3 each share. Thus, this issue will be a 3-for-10 rights issue.
In other words, for every 10 shares you hold, company A is offering you another three in a deeply discounted price of $3, which is 45 percent less than the original $5.50 price.
As a shareholder, you have three choices with a rights issue.
1. Take up the rights to purchase in full.
To take advantage of the issue in full, you would need to spend $3 for every company A share that you are entitled to buy under the issue.
2. Ignore the rights issue.
You may not have the $900 amount necessary to purchase the additional shares of $3 each, so you can always let your rights just expire, although this is not normally recommended. If you choose to do nothing, your shareholding will be diluted thanks to the extra shares issued by the company.
3. Sell your rights to other investors.
In some cases, rights are not transferable. These are known as “non-renounceable rights.” However, in most cases your rights allow you to decide whether you want to take up the option to buy the shares or sell your rights to other investors or the underwriter.