A rights issue is a method used by companies to raise capital by offering existing shareholders the opportunity to purchase additional shares directly from the company at a discounted price, rather than acquiring them through the secondary market. The number of shares a shareholder can buy is typically proportional to their current holdings.

Key Points

Capital Raising: Companies often use rights issues to generate funds, particularly when they need to pay off debt or require capital for other purposes.
Discounted Shares: Shareholders are given the chance to buy new shares at a reduced price before a specified expiration date.
Trading Rights: Until the expiration date, shareholders can trade their rights on the open market.
Stock Dilution: Issuing more shares dilutes the stock price.
No Obligation: Shareholders are not required to purchase the additional shares.

Characteristics of a Rights Issue

Pre-emptive Rights: Existing shareholders get the first chance to buy new shares, usually in proportion to their current holdings, preserving their ownership percentage.
Discounted Pricing: New shares are offered at a discount to encourage shareholder participation.
Subscription Period: A set timeframe, typically a few weeks, is provided for shareholders to exercise their rights.
Underwriting: Financial institutions often underwrite rights issues to ensure the company raises the necessary capital, even if not all rights are exercised.
Regulatory Compliance: Rights issues must adhere to regulatory standards and often require approval from the company’s board and sometimes shareholders.
Documentation: Companies provide detailed documents, such as a prospectus, explaining the terms, reasons for the capital raise, and intended use of funds.
Market Impact: The announcement of a rights issue can influence the company’s stock price, potentially signaling financial distress or presenting a buying opportunity.

Reasons for a Rights Issue

Expansion: Companies may need significant capital for growth and prefer equity over debt to avoid interest payments.
Project Funding: When debt financing is unavailable, unsuitable, or costly, a rights issue can be a viable alternative.
Debt-to-Equity Ratio: Companies aiming to improve their debt-to-equity ratio or acquire another company might choose this route.
Financial Health: Struggling companies might issue shares to pay off debt and improve their financial standing.

Rights Issue Explained: What It Means for Investors