Definition
A Right Issue refers to a corporate offer to existing shareholders to purchase additional new shares in the company at a discounted price before they are offered to the public. Meanwhile, a Bonus Issue is the issuance of extra shares to existing shareholders for free, proportional to the shares they already own. While both strategies increase the number of shares in the company, a Right Issue raises additional capital, but a Bonus Issue does not.
Key Takeaways
- Right Issue is an offer from a company to its existing shareholders to purchase more shares, usually at a discount, while a Bonus Issue is a dividend declared from the accumulated profits, issuing additional shares to the shareholders without any purchase or payment.
- A Right Issue may result in cash inflow to the company as it involves the selling of new shares, whereas a Bonus Issue does not generate any cash for the company as it involves capitalizing the company’s retained earnings.
- In contrast to Right Issues which sometimes may dilute the earnings per share (EPS) if new shares are not subscribed, Bonus Issues increase the total number of shares while maintaining the same total earnings, which leads to the dilution of EPS.
Importance
The finance terms Right Issue and Bonus Issue are crucial as they pertain to a company’s strategy for fundraising or rewarding shareholders.
A Right Issue, where new shares are offered to existing shareholders proportionally to their current holdings, is typically geared towards raising new capital for the company’s expansion, debt reduction, or other strategic needs.
On the contrary, a Bonus Issue involves distributing additional shares to existing shareholders for free, usually indicative of a company’s good health and surplus earnings.
Understanding this distinction aids investors in interpreting the financial decisions made by companies and their implications for investments, hence placing these terms at the heart of financial literacy.
Explanation
A rights issue, in the context of finance, is primarily used by corporations to raise additional capital, often for purposes such as debt repayment, funding expansion or acquisition, or patching up operating cash flows. Companies offer existing shareholders the “right” to purchase additional shares at a discounted price to the current trading price. Interestingly, this can be seen as a benefit to existing shareholders as they get an opportunity to accumulate more shares while diluting potential ownership of new investors.
Yet, it also indicates a company’s urgent need for capital, which might suggest financial difficulties. On the other hand, a bonus issue is used to distribute accumulated earnings back to shareholders in the form of additional shares instead of dividends. Companies opt for this method when they want to conserve cash for business operations yet reward shareholders at the same time.
This creates wealth for shareholders without impacting the company’s cash reserves significantly. However, it has to be noted that bonus issues don’t add any real value as they lead to a proportionate decline in share prices commensurate with the increase in number of shares. It’s merely a reclassification of reserves into issued capital.
Both rights issue and bonus issue signify important capital structure decisions taken by a business.
Examples of Right Issue vs Bonus Issue
Real World Example – Right Issue: In 2019, Vodafone Idea Ltd, a leading telecom company in India, decided to raise funds to reduce their overall debt. They issued rights shares, offering 2000 shares for every 15 held at a price of INR
50 per share. This allowed existing shareholders to purchase additional shares directly from the company at a discounted price.
Real World Example – Right Issue: Tata Steel, a global steel company, announced in 2018 a rights issue for raising around INR 12,800 crores. The shareholders were offered four shares for every 25 shares held by them at a price of INR 510 per share which was at a discount considering the current market price, leading to an increase in their ownership share.
Real World Example – Bonus Issue: In 2020, an India based technology company, Persistent Systems, decided to issue bonus shares in the ratio of 1:
Meaning, shareholders received one bonus share for every one share held. This bonus issue leads to an increase in the total number of shares owned by shareholders without any additional cost, promoting investor confidence but does not increase the company’s fund as no money is received in exchange for the issue. These examples show how both rights issue and bonus issue serve unique purposes, the major difference being right issue involves raising additional capital by offering shares at a discount to existing shareholders, while bonus issue involves rewarding existing shareholders by providing additional shares for free.
FAQ: Right Issue vs Bonus Issue
What is a Right Issue?
A Right Issue is a method by which companies can sell new shares to their existing shareholders to raise additional capital. The company offers shares to existing investors at a discounted price, proportional to their existing holding. This is made as a right not an obligation; shareholders can choose to buy these new shares or ignore the offer.
What is a Bonus Issue?
A Bonus Issue, also known as a scrip issue or a capitalization issue, is an offer of free additional shares to existing shareholders. These are issued by capitalizing the company’s profit or reserve. In simple terms, a bonus issue is an issue of free additional shares to shareholders.
How do they differ?
The primary difference between right and bonus issues is that in a right issue, the company asks the shareholders to buy new shares, whereas in a bonus issue, the company gives shareholders extra shares without any additional cost. Right issues might dilute earnings per share (if additional shares are bought), while bonus issues increase the total number of shares, maintaining the same overall market value.
What are the benefits of a Right Issue?
The main benefits of a Right Issue are that it allows shareholders to buy additional shares at a lower price, potentially increasing their profits if the price of the shares increases. It also allows the company to raise capital without incurring debt.
What are the benefits of a Bonus Issue?
The main advantage of a Bonus Issue is that it increases the number of shares in circulation, which can lead to an increase in liquidity. Bonus issues also give a signal to the market that the company is in good financial health and expects to make higher profits in the future, which can boost investor confidence.
Related Entrepreneurship Terms
- Shareholders’ Equity: This refers to the residual interest in the assets of the entity after deducting liabilities. It serves as the source of finance for both Rights Issue and Bonus Issue.
- Additional Paid-In Capital (APIC): Also referred to as share premium, it is an account in the equity section of a balance sheet that holds excess amount paid by investors for the company’s shares over and above the par value of the shares. In the context of Rights Issue, APIC plays a key role as shares are issued at a premium.
- Retention Ratio: This is the proportion of net earnings that is retained in the business rather than paid out as dividends. Companies with high retention ratios may prefer Bonus Issues over Rights Issues.
- Dilution: This term refers to the reduction in the ownership percentage in a company as a result of the issuance of more shares. Rights Issue can lead to a dilution of equity if existing shareholders do not subscribe to the new shares.
- Earnings Per Share (EPS): This is the portion of a company’s profit allocated to each outstanding share of common stock. Both Rights Issue and Bonus Issue can affect the EPS of a company.
Sources for More Information
- Investopedia: This comprehensive financial education website provides wide-ranging information about different finance terms, including Right Issue and Bonus Issue.
- MoneyControl: Featured as India’s leading financial information source, MoneyControl offers news and articles regarding Right Issue, Bonus Issue, and other finance terms.
- Economics Help: This website primarily focuses on explaining complex economic and financial terminologies in layman’s terms, with dedicated sections for various finance-related topics.
- Financial Express: An Indian business and finance news portal, providing in-depth articles and discussions on financial terms and markets, including Right Issue and Bonus Issue.
