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What is a Rights Issue of Shares? | Rights and Bonus Issue | Example | Eligibility | Types

What is a Rights Issue of Shares

What is a Rights Issue of Shares in India?

In this article, we are going to discuss “What is a Rights Issue of shares in India?” “What Rights Do Existing Shareholders Have in a Rights Issue?”, etc.

Companies often need to raise external funding to grow their businesses into new markets, to spend on research or pay off debt. The different sources of funding include.

  • Initial Public Offering (IPO) – An IPO is when a private company raises equity capital by offering its stock to the public for the first time.
    However, It could be a new company or an old company that decides to be listed on an exchange
    and therefore goes public.

Also Read IPOs Definition | Types of IPOs | Fixed Price vs Book Building | Investors Types | Eligibility 2021

  • Rights Issue (RI) – The RI of shares is basically the method thru which a company raises additional funds.
    RI is an invitation to existing shareholders to buy additional new shares in the company.
    The company is giving the shareholder the opportunity to increase their shareholding in the company.
  • Follow-on Public Offer (FPO) – If even after the Rights Issue, the company couldn’t raise the funding or has more funding requirements, then the company can use the FPO source to raise funds.

Also Read FPO in Share Market | Difference Between IPO and FPO | How Does an FPO Work?

Why Would a Company Do a Rights Issue?

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This is the main query because if companies go to the bank, they can get a borrowing.
Then why do they go to the rights issue of shares? It turns out that there are some legal reasons for which a company goes for the rights issue and not for external borrowing.
Here are the following reasons for which a company goes for rights issue shares:

  • Growth and Expansion
    Funds are needed when a company plans to grow its business. In other words, raising new capital gives them an opportunity to offer a diverse range of services.
  • Launching new products
    Funds are needed when a company plans to launch a new product.
  • Paying off debt
    When a company wants to pay off its debts to improve its financial health, it can choose the option of the right issue.
    For instance, Reliance Industries Ltd. opted for a rights issue in 2020 to become debt-free. The company used the net proceeds towards repayment of their borrowings.
  • Taking over another company
    When a company aims to look forward to acquiring a new company, it may choose the route of the right issue to raise funds.

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Rights Issue of Shares with Example

A rights issue is a new issue of shares to the existing shareholders of the company.
Generally, if the rights are issued at around the current market price (CMP), then existing shareholders may not be too interested.
Therefore, companies generally issue rights shares at an honest discount to the CMP so that existing shareholders see value in them.
However, it does not mean that a shareholder can purchase unlimited shares.
For instance, a 1:15 rights issue means that one equity share can be subscribed to for every 15 shares held by the investor on a particular date.
Let us take an example for more clarification.

Recently, Reliance Industries Ltd. has announced a rights issue to raise INR 53,125 Cr via a 1:15 rights issue at a price of INR 1257/- per share,
under which all shareholders of the company will have the right to acquire 1 share in the new issuance for every 15 shares they hold in the company on May, which has been set as the record date.

Eligibility

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The company will make an announcement that it is offering the rights share to all existing shareholders on a particular date (i.e. record date).
After the rights announcement, but before the particular date, the shares are known as cum-rights.
Actually, if you do not currently own the shares, but if you purchased them at that time, you will get the rights issue. On a particular date, they become ex-rights. If you purchase them after this day, you do not get the rights issue.

For instance, if the record date is 25th February then the ex-rights date will be 23rd February. Any buy to qualify for the rights will have to be made by 22nd February.
If there are any non-trading days in between then the ex-rights date will be pushed back, therefore.

Right Entitlement Definition

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Rights Entitlement (i.e. RE) is the number of fresh shares that the existing shareholder is eligible to apply for under the rights offer (i.e. RO).
REs are generally based on a ratio of existing shares held.
For instance, Reliance Industries. As of May 2020, if you held 150 RIL shares, you are entitled to apply for 10 rights shares which is your RE.

Types of Rights Issue in India

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There are two types of rights issue of shares, which are as follows:

  • Renounceable RI
    When a renounceable rights issue is offered to a shareholder, He has the option to buy the shares by exercising his right, or ignore the right, or sell his right at the price that the rights are being traded at in the Indian stock market.
  • Non-Renounceable RI
    Shareholder only has the option to buy the shares by exercising their right or ignoring the right.
    However, when these rights are offered the shareholder cannot sell his right to another investor.
    In India, most companies issue renounceable RI.

Many investors tend to confuse a rights issue with a bonus issue. Bonus issue and Rights issue both look very similar to each other, but actually, they are totally different.

Rights Issue and Bonus Issue

Rights and Bonus are entirely different. Bonus issues are largely valued neutral.
What happens in a bonus is that you transfer the amount from the free reserves to the share capital.
Therefore, the Return on Equity and Earnings per Share remain the same.
In the case of rights, You are actually paying an amount to buy additional shares, even it is at a discount.

Bonus Issue(BI)Rights Issue(RI)
An issuer offers these shares free of cost.An issuer offers these shares at a price lower than the prevailing market price of the shares.
No cash flow as shares is given free of cost.The RI results in cash inflow as the shares are given at a discounted price.
Does not affect the market value of the company.Affects the market value of the company.
Section 63 of the Companies Act, 2013 regulates the process of BI.Section 62 of the Companies Act, 2013 governs the process of RI.

What Rights Do Existing Shareholders Have in a Rights Issue?

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There are three choices shareholders can make –

1. Fully or Partially Subscribe

This share can be bought based on the pro-rata rights entitlements(RE) credited to the eligible shareholders of the company on a particular date (i.e. record date).

2. Sell Rights Share

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Shareholders who are not interested in the rights issue can sell their rights in the open market as per the “renunciation of rights issue” norms.
In this method, the shareholder can make profits on the shares and the company will also be able to raise the required capital.

3. No Action

If the issuer isn’t doing well, ignoring the rights share might be the right thing to do. Investing in a financially poor company has been always an unsafe bet.
Do not be lured by the discounts. Do your own investigation before investing in any company.

How to Apply for Rights Issue Online?

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Also Read How to Apply for Rights Issue Online? – Bank or Demat a/c or RTA Website

What Happens to Share Price after Rights Issue?

It is very important for investors to have a good understanding of what such Rights share mean and how can they affect an issuer’s share price and financial performance.

Due to their nature, the Rights issue can have a significant impact on share prices and trading activity in a firm’s security on the day of the announcement.

  • The value of each share may get diluted after the RI announcement.
  • Raising funds via the right issue often creates pressure on the issuer.
  • Investors (s) may lose the holding value if the share price come down after the RI.

Pros and Cons

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Also Read Rights Issue Advantages and Disadvantages – Is Rights Issue Good or Bad in 2021?

Frequently Asked Questions

1. Can the right issue be made at face value?

if shares are offered at a price lower than Face Value, then the issue is at a discount.
The key difference between the Face Value and the Rights Offering Price is the discount.

2. Can a private company issue the right shares?

Yes, All types of Companies (i.e. Public, Private, Listed, and Unlisted) can issue shares via Rights shares. 

3. Can I apply additional shares in the rights issue?

Shareholder(s) can apply for any number of additional shares, however, the allotment of the same will depend on shares available for apportionment and will also be in ratio to your holding, regardless of additional shares applied by applicants.

5. Is the right issue only for existing shareholders?

Yes

6. Can an application be made by cash/cheque?

No

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