What is a Rights Issue and How does it work?

A rights issue is an important corporate action in the share market. The companies listed on the NSE and BSE exchanges often use the rights issue route to raise capital from existing shareholders. Through this process, shareholders receive an opportunity to purchase additional shares at a discounted price in proportion to their current holdings.

Investors holding shares in a demat account on the record date become eligible to receive rights entitlement. Eligible shareholders can either apply for the rights or sell their rights in the share market itself.

This article discusses the concept of rights issues, how it works, types, features, advantages and disadvantages.

What is a Rights Issue of Shares?

A rights issue is a process where the company offers new shares to its existing shareholders at a discounted price. Shareholders receive the right to buy the additional shares based on the existing shareholding ratio.

For example, if the company announces a 1.5 Rights issue, shareholders can buy one additional share for every 5 shares held.

Shareholders receive rights entitlement in their demat account. This entitlement can be used to apply for shares or traded in the stock market, if the issue is voluntarily transferred or rejected.

How Does a Rights Issue Work?

The rights issue follows several important steps.

• Announcement:

The company announces the rights issue plan, issue price, ratio, and record date for eligible shareholders.

• Record Date:

Investors holding shares before the record date receive Rights entitlement in their demat account.

• Rights Entitlement Credit:

Eligible shareholders receive Rights entitlement based on their shareholding ratio through the NSE and BSE systems.

• Application Window:

Shareholders can apply for additional shares during the subscription period using ASBA or online banking.

• Trading of Entitlements:

In renounceable rights issues, shareholders can sell rights entitlements in the market through stock exchanges.

• Allotment:

The company allocates shares after the issue closes and credits shares into the demat account of successful applicants.

• Listing:

Newly allotted shares get listed on stock exchanges for trading after the completion of allotment.

Types of Rights Issue

Here are the multiple types of rights issue structures used by the company.

Traditional Rights Issue

In a traditional rights issue, the company offers new shares to the existing shareholders at a discounted price in proportion to their existing shareholdings.

Renounceable Rights Issue

In a renounceable rights issue, shareholders can sell or transfer their rights entitlement to other new investors through the stock exchange.

Non-Renounceable Rights Issue

In a non-renounceable rights issue, shareholders cannot transfer the rights entitlement and must either subscribe or allow the rights to expire.

Standby Rights Issue

In a stand-by rights issue, investment banks or underwriters purchase unsubscribed shares, ensuring the company raises the targeted capital amount.

How can you apply for a rights issue?

Applying for a rights issue had become simple due to online banking and demat account integration. Here is the step-by-step process for it.

• Check Eligibility:

Investors must hold company shares before the record date to receive rights entitlement in their demat account.

• Verify Rights Entitlement:

Shareholders can verify credited Rights entitlement through broker platforms or depository participant statements.

• Open Application Portal:

Investors can apply using ASBA through internet banking or broker-supported rights issue applications.

• Enter Application Details:

Investors enter Rights entitlement quantity and additional shares, if allowed, during application submission.

• Make Payment:

Application amount gets blocked in bank accounts until allotment confirmation under the ASBA process.

• Receive Allotment:

Successful applicants receive allotted shares directly into their demat account after issue closure.

• Trade Additional Shares:

Investors can trade newly allotted shares on the NSE and BSE after listing approval.

Features of Rights Issue of Shares

Here are a few important features of the rights issue, which differentiate them from other corporate actions.

• Discounted Pricing:

Companies generally offer shares below prevailing market prices to attract more shareholder participation.

• Proportionate Allocation:

Existing shareholders receive rights according to their current shareholding pattern and ownership percentage in the company.

• Priority to Existing Investors:

Current shareholders receive the first opportunity to invest before shares become available to external investors.

• Tradable Rights Entitlement:

Renounceable Rights issues allow shareholders to trade rights entitlement through NSE and BSE platforms during limited periods.

• Faster Fundraising Process:

Rights issues usually involve fewer regulatory complexities compared to IPOs and institutional fundraising methods.

• Dilution Risk:

Shareholders not participating may experience reduced ownership percentage due to increased outstanding shares after allotment completion.

• Lower Fundraising Cost:

Companies save on underwriting, marketing, and advertising expenses compared to initial public offerings and follow-on issues.

Reasons for Rights Issue of Shares

Here are several reasons why a company may decide to opt for a rights issue of shares.

• Debt Reduction:

Companies use raised capital to repay existing loans and improve balance sheet strength and financial stability.

• Business Expansion:

Firms raise funds for capacity expansion, acquisitions, infrastructure projects, and operational growth initiatives.

• Working Capital Needs:

Businesses require additional funds for inventory management, operational expenses, and short-term liquidity requirements.

• Regulatory Compliance:

Companies may raise funds to maintain regulatory capital requirements and financial compliance standards.

• Avoiding External Borrowing:

Rights issues help companies avoid excessive debt and reduce interest payment burdens on future earnings.

• Supporting New Projects:

Companies use Rights issue proceeds for launching new products, technologies, or strategic business ventures.

• Strengthening Shareholder Base:

Rights issues encourage existing shareholders to maintain ownership participation and support long-term business growth.

• Financial Restructuring:

Distressed companies sometimes use Rights issues for restructuring operations and improving financial sustainability.

Benefits of Rights Issue For Shareholders

The rights issue had several benefits for shareholders. Here are a few of them.

• Opportunity to Participate:

The existing shareholders get the exclusive opportunity to participate in the rights issue. This gives them a chance to increase their shareholdings by investing in the same company shares at a discounted price.

• Prevent Dilution:

By exercising their rights, existing investors can maintain their proportionate ownership percentage. It prevents ownership dilution when the company issues new shares to the public.

• Increase Potential Returns:

By adding more shares at discounted prices, investors can increase overall returns if the company’s growth strategies, financed by the rights issued, succeed.

• Increased Investment Flexibility:

Investors can choose partial subscription, full subscription, or sale of Rights entitlement according to financial goals.

Disadvantages of Rights Issue For Shareholders

Despite the benefits, there are several disadvantages of rights issue:

• Dilution Risk:

Non-participating shareholders experience reduced ownership percentage and voting power after additional shares are issued.

• Negative Market Sentiment:

Investors may interpret rights issues as signs of financial stress or insufficient internal cash generation.

• Temporary Share Price Pressure:

Share prices often decline temporarily because discounted Rights issue pricing affects market valuations.

• Complex Decision Making:

Investors must evaluate company fundamentals carefully before subscribing to rights entitlement opportunities.

• Reduced Earnings Per Share:

Increased outstanding shares may reduce earnings per share until business growth improves profitability.