3 Facts You May Not Know About Rights Issues
Companies which are already listed on the stock market may still periodically turn to the market to raise more money. There are several ways of doing this: The company can either issue more shares to institutions or select individuals (known as a secondary offering or private placement); issue bonds or notes (which are both forms of debt) that are traded on the stock market; or conduct a rights issue.
In this article, I shall explore three facts investors should know about rights issues.
First, let’s define a rights issue. It is an invitation to existing shareholders to subscribe for additional new shares in the company. The purpose of the rights issue is to raise money for the company for a variety of reasons: Business expansion; mergers and acquisitions; or simply to shore up a weak balance sheet.
A rights issue is, in effect, asking existing shareholders to cough up money in order to bolster the equity base of a company. The company in question would normally detail the reasons for its rights issue and what it hopes to achieve from the funds that are raised. Shareholders have to weigh the pros and cons to assess if the company’s rights issue can indeed achieve the stated objectives, and decide accordingly if they wish to participate.
Issue priced at a discount
The issue price of rights shares will almost always be at a discount to the last done market price of the company’s shares. The company’s announcement of the rights issue would normally state the quantum of the discount and compare the issue price to both the last traded price of its shares and also the volume-weighted-average-price (VWAP). The VWAP is essentially a weighted share price based on the volume of the company’s shares that are transacted at various price levels, over the preceding few days.
The discount is to enable existing shareholders to purchase more shares in the company at a cheaper price. Some rights issues are also known as preferential offerings, as the issue allows existing shareholders to buy shares of the company at a preferential price which new investors are not able to obtain. Shareholders should note, however, that if the discount to market price is too large, it may result in substantial dilution to the company’s earnings (I will cover this in a future article, so stay tuned!).
Rights shares can be traded over the stock exchange
Some rights issues (known as renounceable rights issues) involve rights shares which can then be traded on the stock exchange. Shareholders who do not wish to exercise their rights to purchase shares at a discount can choose to sell their rights to other buyers, who are then able to use the rights to subscribe for new shares of the company at the issue price. This is useful for shareholders who do not wish to or can’t cough up more money to participate in a rights issue.