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Features of Rights Issue of Shares

Rights shares allow existing shareholders preferential treatment to purchase additional shares at a discounted price by a specified date. A company may conduct a rights issue to raise large amounts of capital for expansion projects when debt funding is unavailable or too expensive. Key features include existing shareholders receiving the right to purchase shares in proportion to their existing holdings at a discount to the market price within a specified timeframe.

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199 views3 pages

Features of Rights Issue of Shares

Rights shares allow existing shareholders preferential treatment to purchase additional shares at a discounted price by a specified date. A company may conduct a rights issue to raise large amounts of capital for expansion projects when debt funding is unavailable or too expensive. Key features include existing shareholders receiving the right to purchase shares in proportion to their existing holdings at a discount to the market price within a specified timeframe.

Uploaded by

Haunter khan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Rights Issue

• When listed company issue fresh securities to existing shareholder to raise capital

• According to the section 81 of the companies Act 1956, if a public company wants to increase
its subscribed capital by allotment of further share after two years from the date of its
formation or one year from the date of its allotment, whichever is earlier, should offer share
first to its existing shareholders in proportion to the share held by them at the time of offer.

• CONDITIONS:

• A notice should be issued to specify the number of shares issued

• The time given to accept should not be less than 15 days

• Right of the share holders to renounce the offer in favor of others

• A rights issue is one of the ways by which a company can raise equity
share capital among the various types of equity share capital sources available.
These are slightly different from the standard issue of shares. Right shares mean
the shares where the existing shareholders have the first right to subscribe the
shares.
• In layman terms, rights issue gives a right to the existing shareholders to
purchase additional new shares in the company. Rights shares are usually
issued at a discount as compared to the prevailing traded price in the market.
The existing shareholders are allowed a prescribed time limit/date within which
need to exercise the right or the right will thereafter be forgone.

• A company may look to raise a large amount of capital for expansion projects
which may have a longer gestation period.
• A project where debt/loan funding may not be available/suitable or expensive
usually makes company to raise capital via this route.
• Companies looking to improve debt to equity ratio or looking to buy a new
company may opt for funding via rights issue route.
• Sometimes troubled companies may issue rights shares to pay off debt to ease
the financial strain.

FEATURES OF RIGHTS ISSUE OF SHARES


 The rights shares allow preferential treatment to existing shareholders, where existing
shareholders have the right to purchase shares at a lower price on or before a specified
date. The shares are issued at a discount as a compensation for the stake dilution that
will take place post issue of additional shares.
 The existing shareholders can trade the rights to other interested market participants
until the date at which the new shares can be purchased. The rights are traded in a
similar way as the normal equity shares.
 The amount of rights issue to the shareholders is usually at a proportion of existing
holding.
 The existing shareholders can also choose to ignore the rights; however, one may not
do so as existing shareholding will be diluted post issue of additional shares and will
result in a loss (in valuation) for existing shareholder.

WHY DOES A COMPANY ISSUE RIGHTS SHARES?


 A company may look to raise a large amount of capital for expansion projects which
may have a longer gestation period.
 A project where debt/loan funding may not be available/suitable or expensive usually
makes company to raise capital via this route.
 Companies looking to improve debt to equity ratio or looking to buy a new company
may opt for funding via rights issue route.
 Sometimes troubled companies may issue rights shares to pay off debt to ease the
financial strain.
Having looked at the features, let us look at an example of a rights issue.
RIGHT ISSUE EXAMPLE
Let us say an investor owns 1000 shares of ABC Ltd. and the shares are trading at a
price of $10. ABC Ltd. announces a rights issue in the ratio of 2 for 5, i.e. each investor
holding 5 shares will be eligible for 2 shares from the new issuance. The company
announces a discounted price of say $6 per share. This means that for every 5 shares
of value $10 held by an existing shareholder, ABC Ltd will offer 2 shares at a discounted
price of $6.
Portfolio Value before Rights Issue = 1000 shares X $ 10 = $ 10,000

No. of Right Shares to Be Received = (1000 X 2/5) = 400


Cost of Purchasing New Shares Using the Rights = 400 shares X $6 = $ 2,400
Offer for sale
Offer for sale (OFS) is a simpler method of share sale through the exchange platform for listed
companies. The mechanism was first introduced by India’s securities market regulator Sebi, in
2012, to make it easier for promoters of publicly-traded companies to cut their holdings and
comply with the minimum public shareholding norms by June 2013. The method was largely
adopted by listed companies, both state-run and private, to adhere to the Sebi order. Later, the
government started using this route to divest its shareholding in public sector enterprises.

Description: Unlike a follow-on public offering (FPO), where companies can raise funds by
issuing fresh shares or promoters can sell their existing stakes, or both, the OFS mechanism is
used only when existing shares are put on the block. Only promoters or shareholders holding
more than 10 per cent of the share capital in a company can come up with such an issue.

The mechanism is available to 200 top companies in terms of market capitalisation. In an OFS,
a minimum of 25 per cent of the shares offered, are reserved for mutual funds (MFs) and
insurance companies. At any point, no single bidder other than these two institutional categories
is allocated more than 25 per cent of the size of the offering.

A minimum of 10 per cent of the offer size is reserved for retail investors. A seller can offer a
discount to retail investors either on the bid price or on the final allotment price. The OFS
window is open only for a single day. It is mandatory for the company to inform the stock
exchanges two banking days prior to the OFS about its intention.

This has a key advantage over follow-on public offer (FPO), which stays open for three to 10
days, and takes considerable time, as it requires filing of draft papers and obtaining necessary
approvals from Sebi. In OFS, the entire retail bid amount is backed by 100 per cent margins in
the form of cash and cash-equivalent. The process is quick and any excess fund, due to non-
allotment or partial allotment, is refunded to the trading member on the same day, after 6 pm.

Bids backed by 100 per cent margins are allowed to be modified anytime during the OFS hours.
Nonetheless, those with zero per cent margin can only be modified upwards, for revision in price
and quantity. No cancellation is permitted in such bids.

Bids below the floor price are rejected. The allocation remains subject to final price discovery.
An FPO, on the other hand, defines a price band within which bids are placed.

The floor price is generally set at a discount to the prevailing price. But sometimes things go
overboard. Take the example of MMTC. In June 2013, the OFS was offered at a steep discount
of 72 per cent, thanks to low free-float shares (and hence low volumes) and premium valuations
on lack of efficient price discovery mechanism. The stock crashed and now trades way below its
pre-OFS price.

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