Investment word of the day: Rights issue of equity shares— what it means and why companies offer it

Investment word of the day: Companies initiate several corporate actions to generate capital, increase profitability or conduct corporate restructuring, while usually keeping in mind the interests of the existing shareholders. One such corporate action is a rights issue.

What is rights issue of equity shares?

A rights issue of equity shares is a corporate action through which a company aims to raise capital by offering the right to purchase additional shares to the existing shareholders at a discounted price in proportion to their shareholding.

Right issue of equity shares — an example

For example, a shareholder owns 100 shares of a company with a face value of ₹10 each. The company announces a rights issue in a 1:5 ratio. The discounted price of the new shares is set at ₹6 per share. Hence, for every five shares at ₹10 each, owned by an existing shareholder, the company will provide one rights share at a discounted price of ₹6.

Rationale behind rights issue

A company typically tries to raise capital through a rights issue by providing an opportunity to purchase additional shares, mostly at a discounted price. This corporate action enables a company to generate funds to cater to several business needs, including expansion, clearing debts, or opting for strategic initiatives. Further, it allows companies to maintain control, allowing existing shareholders to increase their stake.

Key features of rights issue

Announcement of rights issue

A listed company declares the date on which it plans to issue equity shares to existing shareholders.

Proportion of allocation

The right to purchase additional shares depends on the existing proportion of shareholding. Each existing shareholder is given rights issued in proportion to the total number of shares they own.

Subscription price for new shares

The subscription price for additional shares is determined by the company, which is typically lower than the present market price. This motivates existing shareholders to subscribe to these shares.

Right to trade

In certain cases, shareholders have the option to trade their rights on the stock market. Existing shareholders who do not want to acquire additional shares can sell these rights to other investors in the market.

Time period to buy new shares

The existing shareholders are provided a designated timeframe to exercise these rights and buy new shares. In case it is not exercised in the given time period, the rights may expire.

Disclaimer: This article is for informational purposes only and does not constitute financial advice; please consult a qualified financial advisor before making any financial decisions.