Definition
A rights issue is a method companies use to raise additional capital by offering existing shareholders the right to purchase new shares at a discount to the current trading price. This is often done proportionally to their existing holdings. It’s a way for companies to generate funds for potential investment or to pay down debt.
Key Takeaways
- A Rights Issue is a method by which a company can raise additional capital by offering new shares to existing shareholders, proportionate to their current shareholdings, often at a discounted price.
- It benefits the company by providing a quick and relatively less costly way to raise funds. For investors, it provides an opportunity to increase their stake in the company at a discounted price.
- However, rights issues can sometimes lead to dilution of earnings per share if the funds raised are not effectively employed. Also, if shareholders do not subscribe to the rights offer, their stake in the company gets diluted.
Importance
A rights issue is of significant importance in the field of finance because it paves the way for companies to raise additional capital without resorting to borrowing.
This is a privilege extended to existing shareholders, enabling them to purchase additional shares in proportion to their existing holdings at a discounted price.
It provides companies a streamlined method of sourcing funds for expansion, debt repayment, or potential acquisitions.
For shareholders, rights issues often present an opportunity to increase their investment at a lower cost, thereby making it a strategic and cost-effective investment strategy.
Hence, understanding rights issues is essential for investors in their decision-making process as it directly impacts their investment value and future growth prospects.
Explanation
A rights issue serves as a strategy employed by corporations to raise additional capital from their existing shareholders. This method generally involves on a scale of preference, where corporations offer their existing shareholders the opportunity to purchase additional stocks in proportion to their current holdings, often at a discounted rate compared to the prevailing market price.
Ultimately, the purpose is rooted in the idea of preserving the company’s ownership structure, rather than diluting it by inviting investments from external shareholders. Moreover, a rights issue is a vital tool designed for financial restructuring by companies faced with the urgency of accumulating adequate capital to pay off debts, fund expansions, or acquire assets.
It is a cost-effective solution to circumvent the expensive underwriting fees associated with the public issuance of shares. As it’s a negotiation between the company and its existing shareholders, it often creates an attractive incentive for shareholders as it permits them to increase their stake in the company without prohibitive costs.
Examples of Rights Issue
Santander Rights Issue – In 2017, Spanish bank Santander performed a rights issue as part of their financing package to acquire Banco Popular. Santander offered €7 billion of shares to its existing shareholders. This allowed Santander to maintain their financial solidity after the acquisition and kept them in a strong position in the European banking sector.
British Petroleum (BP) Rights Issue – In 2010, BP chosen the path of a rights issue to help cover the huge costs they faced due the Deepwater Horizon oil spill, one of the largest environmental disasters in US history. BP raised about £12 billion from this rights issue.
Vodafone Qatar’s Rights Issue – The company initiated a rights issue in 2016 to cover their losses. Vodafone Qatar offered
43 billion new shares at a price of QR
00 per offer share. This strategy was implemented to strengthen the company’s financial position and to increase its capability to continue investing in key strategic areas.
Frequently Asked Questions about Rights Issue
1. What is a ‘Rights Issue’?
A ‘Rights Issue’ is a method used by companies to raise new capital by offering existing shareholders the right to purchase additional shares in the company at a discounted price, before these shares are offered to the public. The number of new shares that can be acquired by each shareholder is generally proportional to their existing holdings.
2. What happens if I don’t purchase during a ‘Rights Issue’?
If you choose not to exercise your rights during a ‘Rights Issue’, your ownership stake in the company reduces, as the total number of shares in the company has increased. This is often called dilution. Theoretically, the price of your shares may fall, but this is not always the case, as the impact of a ‘Rights Issue’ on share price is dependent on several factors.
3. Who benefits from a ‘Rights Issue’?
A ‘Rights Issue’ can often be advantageous for existing shareholders, as they are usually offered the new shares at a discounted price. However, it’s not always a clear benefit. The company also benefits by raising additional capital without increasing its debt.
4. Do I have to participate in a ‘Rights Issue’?
No, participation in a ‘Rights Issue’ is optional for existing shareholders. If a shareholder decides not to participate, they can often sell their rights to other investors.
5. How is the price of a rights issue determined?
The price of a ‘Rights Issue’ is typically lower than the market price of the shares. It is decided by the company issuing the shares and is often set at a level to encourage take-up by shareholders.
6. What is the process of a ‘Rights Issue’?
The process of a ‘Rights Issue’ generally involves the company first deciding the number of shares it wants to issue and the discounted price. The company then sends a letter to its shareholders, explaining the ‘Rights Issue’ and giving them a specific time period in which to decide whether or not to participate.
Related Entrepreneurship Terms
- Pre-emptive Rights
- Underwriting Agreement
- Financial Dilution
- Issued Shares
- Convertible Securities
Sources for More Information
- Investopedia: A comprehensive website that provides definitions, explanations, and articles on a wide range of finance-related topics, including Rights Issue.
- Corporate Finance Institute: This site offers professional training and free resources on financial analysis concepts, including Rights Issue.
- Financial Times: An international daily newspaper with a particular focus on business and economic news. It often provides analysis on specific finance concepts like Rights Issue.
- The Economist: Another international weekly newspaper printed in magazine-format and published digitally that focuses on current affairs, international business, politics, technology and culture. It’s a great resource for more analysis about the Rights Issue.
