Publicly listed companies often require additional capital to give shape to their expansion plans, improve debt to equity ratio, bring about infrastructural development, or to pay off existing debts. In this situation, they may release the rights issue of shares to existing shareholders. It is a practical choice, as companies do not require any additional loans from banks at a high-interest rate. Instead, they can raise the capital from stock owners without even incurring underwriting fees.
Here, investors get an opportunity of purchasing stocks directly from the company at a discounted price rather than visiting the secondary market. The number of shares that shareholders will own depends on their existing holdings.
Example of the Rights Issue of Shares
Let us consider that an existing shareholder already owns 200 shares of Britannia Industries Ltd, currently trading at Rs 3,730 per stock. Now, if Britannia wishes to raise some additional capital, it may announce the rights issue in the ratio of 3 for 10. These stocks will be available at a discounted price of Rs 3500 per share. It suggests that existing shareholders can subscribe for 3 additional shares if they already own 10 shares. Let us find more about this deal.
- Investor’s Portfolio Value (before the company announced the rights issue) = 200 X Rs 3730= Rs 7,46,000
- Total number of shares, the investor can subscribe = (200 X 3/10) = 60 shares
- Cost of the rights shares = 60 X Rs 3500 = Rs 2,10,000
- Total number of shares after the transaction = 260
- Revised Value of the portfolio = Rs 7,46,000 + Rs 2,10,000 = Rs 9,56,000
- The cost price per share after exercising rights issue = Rs 956000/260 = Rs 3676. 92
How to buy rights issue shares?
Existing shareholders can subscribe for more stocks when the company announces a rights issue. They order the shares on the ‘record date’ through ASBA (Applications Supported by Blocked Amount) process. Here stock owners pay a specific amount at the time of subscription, and the balance amount after the allotment. You can initiate the rights issue through your online trading account if you have enabled this feature. Fill in the financial details like folio number, the number of rights shares and place the orders. You would receive a confirmatory e-mail from the company about the authentication of subscription.
It is crucial to keep in mind a few important financial tips while opting for rights issue shares. Investors should not increase their exposure to stocks, merely considering the discounted pricing. Instead, introspect the financial performance and the growth prospect of the company before subscribing for such shares. It will help you gain an insight into the real reason behind the issue of additional shares.
In most cases, corporate actions like the rights issue significantly impact the share prices and trading activity at the exchange on the day of the announcement. The stock prices get diluted with the introduction of more shares, and there may be a downward trend in the valuation of these shares. So, accurate and timely information about corporate actions like rights issue can help in making crucial financial strategies.
Advantages of the Rights Issue of Shares
Now, that you have comprehensive knowledge about the meaning of the rights issue, let us have a note of the right issue share advantages.
- The rights issue shares come at a discounted price, and investors can directly purchase them from the company instead of visiting the secondary market. ∙
- Companies do not require underwriting charges and advertisement costs while issuing rights shares. So, it is a cost-effective option for the issuer as well.
- The administration and control of the firm remain limited within existing stock owners. Outsiders do not have the privilege of purchasing rights shares.
- The allotment process of rights shares is systematic and depends on the present holding of existing shareholders.
Disadvantages of the Rights Issue of Shares
Despite several benefits, there are some rights issue to share disadvantages. Let us look at them one by one.
- Rights issue may not raise sufficient funds for the company to accomplish its goals. It occurs when existing shareholders do not seem interested in further investing in the concern by increasing their exposure to the stocks.
- There is a chance of dilution in the value of stocks due to the increased number of shares.
- There can be a negative sentiment about the future of the company among investors when they announce a rights issue. Shareholders may presume that the firm is struggling with its expansion initiatives or have huge debts. It led to bidding for additional capital from the shareholders.
So, this was all about the meaning, advantages, and disadvantages of the rights issue of shares. You can consider purchasing additional stocks at a discounted price through this process, provided you have sound knowledge about the financial condition and expansion plans of the issuing company.
