Question 1

What is the purpose of a rights issue?

Accepted Answer

Companies use rights issues primarily to raise capital. By offering additional shares to existing shareholders at a discounted price, they can strengthen their finances while giving current investors a preferential opportunity to invest further.

Here are the main purposes:
• **Fundraising for business growth:** To finance expansion, new projects, technology upgrades, or acquisitions that support long-term development.

• **Debt reduction:** To repay or reduce existing borrowings, which lowers interest costs and improves the company's financial health.

• **Strengthening capital structure:** To increase equity capital and reduce the debt-to-equity ratio, making the balance sheet stronger and more stable.

• **Preserving shareholder control:** To allow existing shareholders to maintain their proportional ownership and prevent dilution by new investors.

• **Cost-effective fundraising:** To raise capital faster and at a lower cost compared to public issues, loans, or private placements.

• **Building shareholder confidence:** To signal management's commitment to growth and a stronger financial future, which can boost investor trust.

Question 2

Who is eligible for a rights issue?

Accepted Answer

Only shareholders whose names are recorded in the company's shareholder register on the specific "record date" are eligible for a rights issue.

• **Existing shareholders on the record date:** You must hold shares of the company as of the record date to receive the rights entitlement.

• **Renouncees (transferees of rights):** If a shareholder transfers (sells or gifts) their rights entitlement to another person during the trading period, that recipient (known as a renouncee) then becomes eligible to apply for the rights shares.

**Note:** To subscribe to and receive rights shares, the eligible shareholder or renouncee must have an active demat account where the newly allotted shares can be credited.

Question 3

Is a rights issue good or bad?

Accepted Answer

A rights issue isn't inherently good or bad; its value depends on the company's reasons for raising funds and its overall financial health. If a company uses it to finance growth and communicates this clearly, it's often seen as a positive sign. However, if it's primarily to cover losses or repay old debts, it might not be beneficial for investors.

**Advantages of a Rights Issue:**
• **Buy at a discount:** You get the opportunity to purchase additional shares below the current market price.

• **Increase your stake:** It allows you to maintain or even increase your ownership percentage in the company.

• **Profit from renunciation:** If you don't want to subscribe, you can often sell your rights entitlement in the market for a profit.

**Disadvantages of a Rights Issue:**

• **Dilution risk:** If you don't participate, your percentage of ownership in the company may decrease.

• **Potential drop in share value:** The market price of the shares might fall after the issue due to the increased supply.

• **Earnings impact:** The Earnings Per Share (EPS) might decrease because there are now more shares outstanding.

Question 4

Is a rights issue mandatory or voluntary?

Accepted Answer

For shareholders, a rights issue is completely voluntary. While the company offers additional shares based on your current holdings, you are not obligated to subscribe.

For renounceable rights issues (which are the most common type), shareholders have several choices:
• Renounce (sell or transfer) their rights entitlement, allowing someone else to buy the shares.

• Let the rights lapse (expire) without taking any action.

• Purchase only part of their entitlement and let the rest expire.

• Purchase the full entitlement offered to them.

• Buy additional entitlement if the company allows for oversubscription.

• Purchase the entitlement and then sell it (in full or in part) to another investor.

**Note:** Since participation is voluntary, investors have the flexibility to decide how much to invest or whether to participate at all. It's important to remember that the options listed above primarily apply to renounceable rights issues. For non-renounceable rights, shareholders typically must either subscribe to their full entitlement or let it lapse.

Question 5

What happens during a rights issue?

Accepted Answer

A rights issue is an optional offer of additional shares that a company makes to its existing shareholders when it needs to raise funds. This is typically for purposes like expansion, debt repayment, or managing working capital. These shares are offered at a discounted price for a limited period, giving current shareholders the first opportunity to buy more before anyone else.

Here's a typical breakdown of what happens:
• Each existing shareholder receives a proportionate entitlement to buy additional shares (for example, 1 new share for every 5 shares they already hold).

• Shareholders can choose to subscribe fully, subscribe partly, sell their entitlement (renounce), or simply let the offer expire, as participation is voluntary.

• If shareholders do not subscribe, their rights will expire after the issue closes.

• The subscription period typically lasts between 16 to 30 days.

• The company receives fresh capital once the shares are allotted to subscribers.

• After allotment, the market price of the shares usually adjusts to reflect the additional shares issued (a process known as price dilution).

Essentially, existing shareholders receive preferential treatment in a rights issue, meaning they are prioritized over new investors for this specific offer.

Question 6

What is Rights Entitlement (RE) in shares?

Accepted Answer

Rights Entitlement (RE) is a temporary, tradable instrument that a company issues to its existing shareholders when it announces a rights issue. It represents your right (but not your obligation) as a shareholder to subscribe to additional shares at a discounted price.

Shareholders receive these entitlements in proportion to their existing holdings. For example, if a company announces a rights issue in a 2:5 ratio, it means you can buy 2 new shares for every 5 shares you already own.

These Rights Entitlements are credited to shareholders' demat accounts and can be traded on the stock exchange during the issue period. This offers flexibility to those who may not wish to subscribe directly.

Question 7

Is it a good idea to buy rights issue shares?

Accepted Answer

Buying shares through a rights issue can often be a good opportunity, but it truly depends on the company's financial health and your personal investment goals. As with any investment, there are both advantages and disadvantages.

It might be beneficial if you:
• Want to buy more shares at a discounted price, typically below the current market rate.

• Believe in the company's long-term growth and want to maintain or increase your ownership stake.

• Prefer to resell your Rights Entitlement (RE) in the market for a profit if you decide not to apply for the shares yourself.

However, it could be disadvantageous if you:

• Are not confident about the company's future performance or its financial position.

• Expect the share price to fall significantly after the rights issue.

• Believe the Earnings Per Share (EPS) may decline due to the increased number of shares outstanding.

In summary, a rights issue is generally worth considering when the company has strong fundamentals, a clear and positive purpose for raising funds, and active participation from its promoters. It's often best to avoid it if the primary goal is merely to cover losses or repay existing debts.

Introduction to Rights Issues

Rights Issue Meaning

Rights Issue Features

Rights Issue Purpose

Types of Rights Issues

A. Based on Payment Terms

1. Full Payment at the Time of Application

Example:

1. Part Payment with Balance as Call Money

Example:

B. Based on Transferability of Rights

1. Renounceable Rights Issue

1. Non-Renounceable Rights Issue

Rights Issue Advantages

Rights Issue Disadvantages

Rights Issue Example

Rights Issue Good or Bad

Key Takeaways

Frequently Asked Questions