When I wrote about the different types of share issues public companies can make I received a request to give a bit more depth and detail into the various types of issues. Not being one to disappoint a reader I thought we should have a look at the various issues starting with the rights issue. While rights issues seem like a simple process that a company uses to raise additional capital, the rights issue can have massive implications for both the company and the shareholder. Let’s discuss how.
In a rights issue, the company offers existing shareholders a right but not an obligation to buy additional shares in the company at a price that is discounted from the market price. The rights are offered to shareholders on a proportional basis to their holding so you may have a 1 for 4 rights issue which offers the right to buy 1 share for every four shares held. As mentioned this is not an obligation and it is not mandatory to participate in the rights issue, we will take a look at the options available to shareholders in a rights issue.
Raising additional capital
Rights issues are conducted mainly as a method for the company to raise additional capital from existing shareholders. The company is receiving additional capital from shareholders. The rights are rights to buy additional shares. The capital raise will be done at a discounted price to market price in most if not all cases. So say you have Company X, with shares that have a market value of $1. They make a 1 for 5 rights issue at 10 cents per share. This means that for every 5 shares you hold you will receive the right to buy 1 share at 10 cents. If you hold 10000 shares that work out to 2000 rights to buy at 10 cents each. However, we will see later on that rights issues have other, sometimes unintended consequences.
What can the shareholder do?
As mentioned before these are rights, not obligations and the shareholder has 3 options when it comes to the rights issue. Which course of action to follow will depend on a few factors.
If the shareholder would like additional shares in the company and feels the rights offer is a good deal they can subscribe and will therefore be awarded the rights and can therefore buy the respective number of shares that they are offered. Rights issues tend to have an impact on the market price of shares which we will touch on.
If the shareholder feels that the offer is not good or they cannot afford it they are well within their rights, no pun intended, to decline the offer. In such a case the rights to the shares lapse and no further action being taken. So if a company made a rights offer and all shareholders declined life would go on as normal. No changes in any part of the company or its balance sheet.
In many cases rights are transferrable. What this means is a shareholder has the option to subscribe to the rights but turn around and sell the rights to someone else. Why would a company make rights transferrable? At the end of the day, the company is looking for a capital injection and if your existing shareholders are not willing or able to transferability means they have an incentive to move on the shares to someone willing to inject capital. The rights price is calculated using the formula (Market price -rights price)/number of rights needed to buy 1 share. Using our Company X example a right would be worth 18 cents ([100-10]/5).
Where rights are exercised they will increase the capital that the company has on hand to the extent that they are exercised.
The market price is likely to decline as you have a greater number of shares being attributed to an amount of capital that has not proportionally increased. Market prices depend on other factors so this is only a possibility, not a foregone conclusion.
If some members do not take-up rights while others do the shareholding proportions will change. If rights are sold to other parties this can also change the shareholding proportions. Rights issues can be very unpredictable in this regard.
The most recent rights issue on the ZSE is the early 2020 offer made by retailer Edgar’s to its shareholders. I recommend you go and read about this as it really makes a great case study of all that is good and bad about rights issues.