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Understanding Rights Issues – 5 Essential Things To Know

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Don’t worry, you’re not the only stock market investor who gets confused by technical terms like rights issue. Many investors steer clear of this path for a lack of understanding or possibly because they find the complexity off-putting.

Therefore, we have created this article that will cover every aspect of the rights issue, starting from the fundamentals— what is right issue of shares—and going on to common types, eligibility, and the application process. We will also discuss the pros and cons before adding some practical advice, to finish off the meal and help you make better decisions.

So, let’s get started on your journey!

What is the Right Issue Meaning?

A company needs finances to operate, especially if it’s trying to find quicker ways to raise money for expansion. Maybe it’s working on a project where getting debt is difficult.  Alternatively, the company may seek ways to improve its debt-to-equity ratio, which could strengthen its financial position.

One fast and low-cost strategy a business can use to generate capital to address its cash shortage is a rights issue. Right issue means simply granting existing shareholders the preferential right to purchase shares at a discount or below the current market price.

It can, however, occasionally be subscribed to at a premium price, that is, at a price greater than the current rate in the market.  It shows the company’s confidence in its prospects for the future and anticipated sharp price increases. This is similar to what Piramal Enterprises announced in 2017 when it announced its rights issue at a premium of Rs. 2378 in a 1:23 ratio.

What are the Types of Rights Issues?

Fully paid rights issue: Upon application, the shareholders must pay the full issue amount. Following payment, the shares are distributed to the shareholders.

Partly paid rights issue: This is where the shareholders only have to pay a partial amount at the time of application. The remaining amount is paid in subsequent calls as per the company’s schedule. The shares are allotted to the shareholders after the final call is paid.

Renounceable rights issue: If the shareholders choose not to exercise their rights, they can do so by selling them to other investors on the open market. The rights are exchanged in the secondary market. The shareholders’ rights can be renounced in exchange for a premium.

Non-renounceable rights issue: This is where the shareholders do not have the option to sell their rights to other investors. The rights are non-transferable and can only be exercised by the shareholders. The shareholders can either subscribe to the rights issue or let their rights lapse.

Who Can Avail Rights Issue Subscription?

The shareholders who can avail of the rights issue subscription own the company shares as of the record date, which is a cut-off date to determine the eligibility for the rights issue.

The record date is usually announced by the company along with the rights issue details, such as the ratio, price, and period of the offer.

The shareholders who buy the shares before the ex-rights date, which is one day before the record date, will be eligible to receive the rights entitlements in their demat account, which shows their eligibility to apply for the rights issue.

The shareholders who buy the shares on or after the ex-rights date will not be eligible to receive the rights entitlements, as they will not be considered existing company shareholders as of the record date.

How Can You Apply For Rights Issue?

Eligible investors may receive an intimation from the company, known as “Rights Entitlement,” a temporary credit of shares showing your eligibility to apply for the rights issue.

The eligibility for receiving RE is typically based on whether an investor holds company shares on a specific record date. The company sets the record date, and investors who own shares as of that date are entitled to participate in the rights issue. 

You can apply for a rights issue online or offline, depending on the availability of the options.

-To apply online, you can use the ASBA (Application Supported By Blocked Amount) process through your net banking platform or the company’s RTA (Registrar and Transfer Agent) website.

-To apply offline, you can fill and submit a Composite Application Form (CAF) that will be sent to you by the company or the RTA via courier or download it from the BSE or NSE websites.

-You need to fill in the following details in the application form: Cheque/DD details (non-ASBA), DP ID, Client ID, PAN number, and signature.

-You need to submit the application form to any SCSB (Self-Certified Syndicate Bank) branch before the closing date of the rights issue.

-You need to ensure sufficient funds in your bank account to pay for the rights shares you apply for.

-You can also sell or renounce your RE to other investors in the secondary market if you do not want to apply for the rights issue or want to apply for a lesser quantity than your entitlement.

-You can check the status of your allotment on the RTA website or the BSE or NSE websites after the closing date of the rights issue.

The pros and cons of a rights issue: A balanced analysis

5 Things You Must Know About Rights Issues Before You Invest

  • One of the primary impacts of a rights issue is the dilution of ownership for existing shareholders. As new shares are issued, the ownership percentage of existing shareholders decreases. Let’s see how. Assume that a company has 100 outstanding shares, and each is worth ₹74.5.

The total market value of the company is ₹7,450. The company decided to issue 50 new shares to its existing shareholders at a price of ₹6 per share. This is a rights issue in the ratio of 1 for 2, i.e., each shareholder can buy one new share for every two shares they already own.

Suppose you own 10 company shares, 10% of the total shares. Your investment is worth ₹745. After the rights issue, you can buy 5 new shares at ₹6 each, costing you ₹30.

Your total investment will be ₹775, and you will own 15 shares of the company. However, the total number of shares in the company will increase to 150, and the market value of the company will rise to ₹7,480. Therefore, your percentage of ownership will decrease to 10%, even though you have more shares.

  • The announcement of a rights issue can lead to adjustments in the stock price. In many cases, the stock price may decrease due to the dilution and the discounted price at which the new shares are offered.

As in the example above, the new shares are issued at a lower price of ₹49.87, which is lower than the original share price of ₹74.5 as it reduces the average value of each share.

  • Rights Entitlements (RE) granted to existing shareholders can be traded in the secondary market. The trading of RE, guided by investor sentiments, can influence short-term price movements as they buy or sell these entitlements.
  • A rights issue is often undertaken to strengthen a company’s financial position. Adding additional capital can improve the balance sheet and provide funds for debt reduction, expansion, or other strategic initiatives.
  • A rights issue is traded in the stock market with a unique ISIN number (International Securities Identification Number)  on the exchanges. An ISIN is a 12-digit alphanumeric code that uniquely identifies a specific security and is valid only for the duration of the rights issue, after which it becomes null and void.

The Bottom Line

In this article, we dived into the deep waters of the rights issue. Let’s condense our learnings so far. The rights issue is a common and effective way of raising capital for a company from its existing shareholders.

Rights issue offers new shares at a discounted price or a premium to its shareholders in proportion to their holdings. It can have various impacts on a company, its shareholders, and the market.

With rights issue, a company can improve the financial position, performance, and growth potential. It can also provide an opportunity, a choice, and a risk for the shareholders. It can also influence the price movements, the trading activity, and the market sentiment of the shares.

What adds to the complexity of the rights issue is the various legal and regulatory requirements and, the uncertainty of its success and outcome. This dynamic process invites careful analysis and evaluation, therefore do your checks prudently before you choose to invest.

FAQs

  1. What is the difference between a rights issue and a bonus issue?

    In contrast to a bonus issue, which distributes shares to current shareholders at no cost in proportion to their holdings, a rights issue offers existing shareholders the opportunity to purchase additional shares at a reduced price.

  2. How does a rights issue affect the earnings per share (EPS) of a company?

    Because a rights issue lowers the average value of each share and increases the number of outstanding shares, it can lower a company's EPS if the issue price is lower than the pre-issue EPS.
    But in the long run, a rights issue can also boost a company's earnings per share if the money raised is invested in lucrative ventures that yield returns greater than the cost of capital.

  3. What are the tax implications of a rights issue for the shareholders?

    Whether the shareholders' exercise, renounce, or allow their rights to lapse will determine the tax implications of a rights issue. If they exercise their rights, they will not be required to pay any taxes during the acquisition of the rights shares; however, capital gains tax will be due upon the sale of the rights shares, subject to the holding period and acquisition cost.
    If they renounce their rights, they have to pay tax on the income from the sale of the rights entitlements as per their tax slab. If they let their rights lapse, they do not have to pay any tax, but they lose the opportunity to buy the shares at a discounted price.

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I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.

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