The stock market gives sea options to investors to make significant gains over time. Even experienced marketers recommend buying some solid shares and keeping them not for months but for years to see big changes and avail real benefits of equity trading. If you are a savvy investor, you might also know the worth of holding shares for a long time.
To increase your confidence and boost your motivation to maintain such a market position, we will explain the meaning of the rights issue with an example. After reading this article, you will have an understanding of how holding such shares can benefit you to generate good returns.
What is Right Issue?
A rights issue means that the company offers its existing shareholders the opportunity to purchase a higher or an additional number of shares at a low price. Generally, the share price is reduced for a certain period. After it, the price of the company shares becomes normal.
Companies use many methods to raise funds, and the rights issue is one of them. When a company issues such shares, it means the shares of shareholders get diluted. However, you get the opportunity to buy a high number of shares at a low price, where the company is offering you more proportion in shares. As a result, the company dilutes its own stake in the company.
Below is an example of the rights issue to give you a clearer picture of this technical term.
Example of Right Issue
Suppose you own 900 shares of XYZ Company listed on the Indian stock exchange, and the share price is currently Rs 250 each. To raise funds, your company launches its rights issue for current investors at a ratio of 1:3 and Rs 200. It means existing shareholders can buy 1 discounted share for every 3 shares already owned by them. You already own 900 shares and can buy 300 additional shares at Rs 200 each. As a result, you will get a discount of Rs 50 per share and Rs 1500 in total.
Things to Know About Rights Issue
- To participate in the rights issue, intraday trading is not allowed.
- The settlement of rights issues finishes on a T+2 basis.
- The company can directly close if there is any shortage of right entitlement.
- The right entitlement trading is available only in pre-open market sessions, not in normal sessions.
- The right entitlement happens with various ISIN, NSE symbols, and BSE script codes.
- The trading for rights issues takes place on the date of issue and mostly gets closed before the closure date of the issue.
- Rights issues are options, not an obligation for existing shareholders to raise their stake in the business.
- To become eligible to subscribe to the rights issue, it’s compulsory to be on record shareholders.
Why Do Companies Issue Rights Issues?
When a company listed in the stock market aims to expand or scale its business, it requires additional funds for various purposes, including paying off debt, purchasing new equipment, and acquiring a new company. Instead of taking debt, many companies may prefer equity shares to avoid paying interest on the taken loan amount. Also, issuing rights is one of the straightforward methods to raise funds if a number of shareholders already have subscribed equity.
Additionally, there can be many cases where debt financing might not be available, or it may be an expensive option for the company, resulting in the issuance of rights issues. The company can also issue rights if they need to improve its debt-to-equity ratio. Some companies can issue rights to minimize the financial burden of paying off debt and maintain the company’s financial health.
Advantages of Rights Issue
- Issuance of rights gives existing shareholders an opportunity to increase their stake in company shares at a low price. An investor can increase their exposure to the company by exercising in this activity. However, the profit and loss on acquired shares will depend on the company’s future performance.
- It gives current investors a chance to buy more shares in the proportional form decided by a company. The shareholder holding a large number of shares purchases more than the investors with a small number of shareholdings.
- The right issue also allows existing investors to protect themselves from the dilution effect when a company issues extra stocks.
Disadvantages of Rights Issue
- If the additional shares issued in the form of rights are being sold out in the open market, it can dilute the stock prices due to the high supply of shares in the share market.
- Subscribing additional shares through rights issues can be risky to buy if the company is witnessing slower growth than other companies in the same industry and category.
- The issuance of rights can also warn that the company is struggling to maintain its financial health.
- Many investors consider rights issues bad news because it often decreases the open market price of shares.
Is It Compulsory to Subscribe Rights Issue?
No, subscribing to rights issues is not compulsory for the existing shareholders. The rights issue is among voluntary actions that may be taken by shareholders to avoid the effect of dilution or buy an additional number of shares at a low price to make higher gains in the future.
Do You Have to Pay for Subscribed Rights Issues?
If you exercise subscribing rights issued by the company, you are liable to pay the required amount (discounted price) set by the company. You are also free to forfeit the shares if you are not willing to subscribe to the additional number of shares.
Can You Sell Rights Issues to Other Investors?
If you are not willing to proceed with rights issues, you can transfer the rights entitlement to other investors. You can use off-market transactions or stock exchange trading activities to proceed with such trade.
The rights issue is the way used by companies to raise capital. Mostly this technique is used by companies listed on the stock exchange and willing to expand their business or reduce the financial burden by issuing an additional number of shares, i.e., rights issue. Investors may or may not subscribe to these to increase their stake in company shares.
However, before you make any decision, it’s ideal to do a performance check and growth trend of the respective company. This way, you can decide whether your decision will help you generate higher gains in the future.