What is a Rights Issue?
When companies wish to raise funds, they usually opt for an initial public offering (IPO) or debt issue (via bonds or debentures). But these are not the only viable options! They can also approach existing shareholders for additional funds through a method known as Rights Issue. In this article, we will explain what a rights issue is, its purpose, and how it works. Let's also understand why companies opt for a rights issue compared to other options, its advantages and disadvantages.
Rights Issue: Explained
A rights issue is a method by which companies raise equity capital from their existing shareholders. This issue provides existing shareholders with securities known as rights. Rights give its holders an option to buy additional shares in the company at a discount. The holders can choose whether to exercise the right. Right is not an obligation to buy shares, but a mere option. Therefore, rights are valued similarly to how options are valued.
Additionally, a rights holder can sell the rights shares via the open market. There are two types of rights: renounceable and non-renounceable rights. If the rights are renounceable, you can sell them on the market like any other security.
The difference between a rights issue and fresh issues or offers for sale (OFS) is that rights issues do not dilute the ownership of existing shareholders.
What is the Purpose of a Rights Issue?
The primary reason for a rights issue is to raise money. It is a method of raising equity capital. The proceeds from the issue will fund various financial initiatives of a company, such as servicing or reducing debt, funding new projects, or simply increasing their cash reserves.
Why Do Companies Opt for Rights Issues?
Compared to other methods, a company may opt for rights issues mainly to retain control and ownership. Issuing new equity shares will dilute the ownership of the existing shares. Dilution occurs because a rights offering spreads a company’s net profit over a larger number of shares. Thus, the company’s earnings per share (EPS) decreases as the allocated earnings result in share dilution.
Before raising new capital from outsiders and diluting the existing shares, a company provides its existing shareholders (including promoters) the opportunity to participate in the capital raising. Therefore, this type of issue is more favourable to the existing shareholders.
Dilution of ownership will also reduce the voting rights of the current shareholders, especially promoters. The discount offered will compensate the investors for the ownership dilution.
How do Rights Issues Work?
Here’s a step-by-step explanation of how a rights issue typically works:
1. Rights Issue Announcement
Before announcing, the company’s board of directors have to approve the decision to raise capital through a rights issue. The number of shares to be issued and the price at which they will be offered is calculated. The price will be at a discount to the current market price. Once all the procedures are completed and the compliance requirements are satisfied, the company will announce the right issue. The announcement will be through various channels such as a regulatory filing with the exchanges, email, and other forms of media.
The issue will also be guaranteed or underwritten by underwriters.
Legal Requirements to Issue Rights
In India, companies are governed as per the Companies Act. Section 62 of the Companies Act, 2013, relates to the ‘further issue of share capital’ and lays down the regulatory or legal framework for rights issues. You can read about the legal requirements here.
2. Declaration of Record Date
The company will establish a record date. Only the shareholders that hold the company’s share on the record date will be eligible for the rights issue. If you own shares before this date, you'll generally receive rights based on your existing ownership.
3. Issuance of Rights
On the specified date, the company issues rights to existing shareholders based on their current holdings. Each right represents the opportunity to buy a certain number of new shares at a discounted price.
4. Trading of Rights
If the rights are renounceable, they can be traded in a secondary market. The period during which these rights can be traded is known as the "rights trading period." Shareholders who may not wish to buy more shares can sell their rights to other investors interested in acquiring the discounted shares.
5. Decision by Shareholders
Shareholders have the option to do one of the following during the rights issue:
Exercise Rights: Shareholders can use their rights to buy new shares at a discounted price. This maintains their ownership stake in the company, preventing dilution.
Sell Rights: Shareholders can sell their rights to other investors. This allows those investors to buy the discounted shares.
Do Nothing: Shareholders who neither exercise nor sell their rights may let them expire. This results in the dilution of their ownership stake.
6. Proceeds to the Company
The company collects funds from shareholders who choose to exercise their rights. These funds are used for the intended purpose, such as debt repayment, expansion, or other corporate initiatives.
7. New Share Issue
After the rights issue period concludes, the company issues new shares to those shareholders who exercise their rights. The number of new shares issued corresponds to the total rights exercised.
8. Ownership Changes
Shareholders who exercise their rights will not be subject to an ownership dilution. Shareholders who did not participate in the rights issue will experience dilution of their ownership stake as a result of the new shares issued.
What Happens When a Company Announces a Rights Issue?
A rights issue increases the number of shares in the market. This will reduce the company’s Debt-to-Equity ratio as there is an increase in equity. This makes it availing additional debt easier for the company.
More importantly, the Earnings Per Share (EPS) of the company reduces. EPS is essentially the profit generated by the company for each of its equity shares. It is calculated by dividing the net profit attributable to equity shareholders by the weighted average number of equity shares for the year. A reduction in the EPS is unfavourable.
Terms in Rights Offering
Rights Issue Ratio
A rights issue ratio specifies how many new shares a shareholder is entitled to purchase or subscribe to for each share they currently own. It determines the proportion of new shares that existing shareholders can acquire.
For example, a 1:10 rights issue means that an existing shareholder can buy 1 share for every 10 shares currently held.
The subscription price refers to the price at which existing shareholders can purchase additional shares as part of the rights offering. It is also known as the exercise price and offer price.
What is an Ex-Rights Date?
The ex-rights date is the date on which the shares of the company begin trading without the attached rights to purchase additional shares at the discounted subscription price.
How to Subscribe to a Rights Issue?
When you are an existing shareholder on the record date, you get Rights Entitlement (RE) shares in your account. The RE will be in the form of temporary Demat securities that will expire if not used for the application or sold. If you do not wish to avail it, you can either usually sell the RE shares in the secondary market, or let it lapse.
To apply for a rights issue, shareholders can use the Applications Supported by Blocked Amount (ASBA) process if their bank supports it. It is very similar to applying for an IPO.
Alternatively, the company's Registrar and Transfer Agent (RTA) will send a Composite Application Form (CAF) via courier to those who cannot apply online. The filled form can be submitted at a Self-Certified Syndicate Bank (SCSB) branch. The forms can also be downloaded from the BSE and NSE websites.
Advantages & Disadvantages of Rights Issue
|Prevents ownership dilution of existing shareholders (if the right is exercised)||This may result in concentrated investor positions compared to those who didn’t exercise the right|
|It shows the company’s commitment to its existing shareholders||Additional required filings and procedures associated with the rights offering|
|A quick way to raise equity capital||Can only raise limited capital|
Example of Rights Issue and Outcome
In 2020, Reliance Industries Ltd (RIL) announced a rights issue to raise capital for reducing debt and funding its ambitious expansion plans, particularly in the digital and retail sectors. The company issued one right share for every 15 shares held by existing shareholders. The subscription price was ₹1,257 per share, which was significantly lower than the market price at that time.
For instance, if an investor held 150 shares of Reliance Industries before the rights issue, they were entitled to purchase 10 additional shares at ₹1,257 each. This opportunity allowed existing shareholders to increase their stake in the company at a discounted rate.
The rights issue was part of RIL's broader strategy to become a global digital and retail powerhouse. The offering was a massive success, receiving overwhelming participation from existing shareholders and even attracting interest from institutional investors. The proceeds from the rights issue, which amounted to around ₹53,124 crore, provided RIL with the financial strength to continue its ambitious growth initiatives.