A ‘rights issue’ occurs where a company’s existing shareholders are offered the opportunity to purchase additional shares in the company in proportion to their existing shareholdings.
How It Works
The company offers the shareholder a specific number of shares at a specific price. The company will also set a time limit for the shareholder to buy the shares. The shares are often offered at a discounted price to encourage existing shareholders to take the company up on their offer.
If the rights issue is ‘renounceable’, the shareholder has three options:-
They can act on the rights and buy more shares as per the specifics of the rights issue;
They can sell their rights on the market; or
They can pass on taking advantage of their rights.
Why Use A Rights Issue
The benefits of a right issue, if availed of by shareholders, are as follows:
Raise additional finance;
Ownership of the company will remain the same;
Can be used to raise capital at times when debt capital is not available;
Will reduce a company’s level of gearing;
Cheaper than a public share issue; and
Can be commenced at the discretion of the directors, without needing the consent of the shareholders or the stock exchange.
The finance raised may be used to improve a company’s cash flow and pay off existing debts. Alternatively, the funding may be used to finance longer-term projects such as the pursuit of growth strategies or in order to fund an acquisition.
For shareholders who exercise their options under the scheme, their shareholding is not diluted and thus they will retain the same voting rights.
A Word Of Caution
Whilst the offer of discounted shares in a company may be tempting, shareholders should be fully aware of the reason for the rights issue. If it is only being used to pay off existing debts, it may not bode well for the future of the company and shareholders should exercise caution with taking up the rights issue and indeed with their current shareholding.
For example, in 2008, Royal Bank of Scotland (“RBS”) persuaded more than 90% of its shareholders to pay up to 200p a share, which was 46% below the share price at the time, to support a record-breaking £12bn rights issue. Within seven months of the rights issue, the Government was forced to bail out RBS with what became a £45bn lifeline. The investors in the rights issue are currently bringing a case against the bank, arguing that they were not given all the facts about the true state of the bank’s balance sheet before the rights issue.