What is Rights Issue?

Issuing rights shares is another weapon in the company's armoury for fundraising. If you think that initial public offerings (IPOs) are the only way a company can raise funds, you can't be more wrong.

By issuing the rights shares, the company entitles or gives right to its existing shareholders to buy new shares of a company at a discounted price.

Right shares are credited to existing shareholders' demat accounts in proportion to their existing shareholding. This credit suggests only a right to apply for the shares at a discounted price. It is not an allotment of shares, so a shareholder will have to apply to get shares at discounted prices.

Thus, existing shareholders and not the public, in general, can buy the rights shares offered.

However, it is noteworthy that the existing shareholders can transfer their rights to other people. This process is called renunciation of right shares.

Right shares are traded for transfer on a stock exchange like any other equity shares.

Issuing the right shares is an easy way of fundraising because it involves fewer regulations. However, issuing the right shares gives out an impression that the company is facing a crisis.

Buying the right shares can be a good opportunity for increased investment in a company at discounted prices.

How a rights issue works

Imagine you own 100 shares in a penny stock called ABC Ltd, which is currently trading at Rs 10 per share. The company wants to raise more money to fund its expansion plans, so it decides to do a rights issue. It offers existing shareholders the right to buy one new share for every two shares they already own, at a discounted price of Rs 8 per share.

In your case, as you hold 100 shares, you are entitled to buy 50 new shares at the discounted price of Rs 8 each. To exercise this right, you need to pay Rs 400 (50 shares x Rs 8 per share).

Now, there are a few things you can do with these rights. You can either:

• Take up your rights and buy the new shares. In this case, you would have a total of 150 shares in ABC Ltd (100 existing shares + 50 new shares).
• Sell your rights in the market. This is like selling an option to buy the new shares at a discounted price. If the market value of your rights is higher than the cost of exercising them, you could make a profit by selling them.
• Ignore your rights and let them expire. If you choose not to take up your rights or sell them, they will expire and you will not be able to buy the new shares at the discounted price.

Some Pros and Cons...

To be eligible for a rights issue, shareholders must own the company’s shares as on record date. This is the date on which the company determines who its shareholders are, based on its share register. If you buy shares after the record date, you will not be eligible for the rights issue.

If a rights issue is oversubscribed, it can be a positive signal to the market that there is strong demand for the company's shares.

In rights issue, shareholders also have the option to take up their rights, sell them or let them expire, which provides them with some flexibility.

However, the announcement of a rights issue can sometimes be perceived as a negative signal by the market, especially if it is seen as a sign of financial distress or a lack of confidence in the company's ability to generate cash internally.

Also, the discounted price at which the new shares are offered can reduce the value of existing shareholders' investments.

It’s important for shareholders to carefully consider the potential benefits and drawbacks before deciding whether to exercise their rights.

Since you're interested in tracking rights issues, check out the list of companies which have announced rights issue recently.