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Do you ever heard of the term ‘Corporate action’? Rights Issue is a type of corporate action. But what type of corporate action the rights issue is, let’s know.
What is Rights Issue?
Rights Issue of shares is a corporate action which means the offer of shares to all the existing shareholders of the company in proportion to their existing shareholding in the company. Offered shares can be equity shares and preference shares and they can be issued to both equity and preference shareholders.
The rights issue is also known as ‘Rights Offering’.
As a company issues bonus shares in a ratio like 1:1 or 3:2, in a similar manner, a rights issue is also announced in a ratio such as 3:4 or 1:10 and the interpretation for the latter ratio is that on every 10 shares held by the shareholder, he/she can subscribe for 1 rights share.
One should notice that, here, in the rights issue, the company isn’t giving free shares as it does in the bonus issues or stock dividends. The company is offering shares which means it will charge money against these offered shares.
Doesn’t the aforesaid situation, where the company is offering the shares and charging the money against them, resemble the public issue of shares, like IPO and FPO, where the company raise capital by issuing shares. Yes, the resemblance is there between public issue and rights issue but the difference is that rights issue is corporate action and the investor knows the issue price before the issue opens while the public issue isn’t any corporate action as well as if the IPO or FPO is a book building issue then the company decides the issue price after the issue closes.
Reasons to raise capital through a rights issue can be many such as:
- To pay off debt
- Company’s expansion
- To meet current financial obligations
- Acquisitions.
Types of Rights Issue
A company can issue fully paid shares or partly paid shares during a rights issue, as it wants, to raise capital. And this leads to 2 types of rights issues: The fully paid rights issue & the Partly paid rights issue.
The procedure for the rights issue will get clear to us when we would know the various important dates related to the rights issue.
Here are some important dates:
- Announcement Date: On this date, the company announces that it will distribute the rights shares. On this date company also announce the ex-rights date, record date, and when it will credit the shares to the account of shareholders. The announcement date is also known as the Declaration date.
- Ex-rights Date: If you want to get the rights or rights entitlement of the rights issuing company, then you must buy the shares of that company before this date.
- Record Date: You must have shares in your demat account on this date to be eligible for the rights entitlement. This date falls a day or two after the ex-dividend date but in most cases, it is one day.
The clearing and settlement process takes 'T+2' days (which is 'Trading date + 2 working days', for example if you buy shares today you will get delivery of shares the day after tomorrow) and mostly ex-rights date falls 1 day before the record date; Therefore, if you buy shares of a rights issuing company even one day before the ex-rights date, you will have the shares in your account on the record date, but if you buy the shares on or after the ex-rights date, you will not be entitled to the rights; as you will not be holding the shares as on the record date.
- Issue Opening and Closing Date: Rights issue duration, between the issue opening and closing date, should be at least 15 days and not more than 30 days. Rights entitlement trading dates fall within this period.
- Rights Entitlement Trading Dates: These are the dates within which the rights entitlements can be traded on the stock exchange. Start from the issue opening date and – generally – closes 3-4 working days before the issue closing date.
- Allotment Date: The date on which the company allots rights shares to the applicants.
- Credit Date: The date on which the rights shares are credited to your demat account.
- Listing Date: Date on which the rights shares are listed on the stock exchange.
How do Rights Issues Work?
Now, you know the different dates related to the rights issue and have pretty good knowledge about the whole procedure for the rights issue of shares, as you now know, the journey from the announcement date to the credit date.
Let’s discuss the terms like rights shares, rights entitlement and renunciation of rights shares and much more to get a clear understanding of ‘how do rights issues work?’
- Rights Shares:
The shares which the company transfers to your demat account on the credit date are known as rights shares.
- Rights Entitlement (RE):
Rights entitlements, also known as rights, are not the rights shares that get credited to your account on the credit date. The issuing company transfers the REs to your demat account after the record date and before the issue opening date.
The quantity of RE(s) depends on the rights issue ratio. Let’s take the example of the 1:10 ratio and say that you’ve 100 shares. Then the number of REs that the company will transfer to your account would be 10.
As we have discussed that a rights issue is a corporate action through which the company raises the capital by offering shares and the investors need to pay money to get these shares. Do you think every shareholder of the company will be in a mood to subscribe to the rights share? It’s not always the case.
Rights have 2 types: Renounceable Rights and Non-renounceable Rights 1. Renounceable Rights: Investors can trade these rights over the stock exchanges. 2. Non-renounceable Rights: Investors can't trade these rights. (Generally, the rights issued by all companies are renounceable rights)
Let’s take your case, where the rights/REs in your account are 10.
- You can apply for all 10 shares.
- You can apply for all 10 shares and also apply for getting additional shares from the company.
- You can apply for all 10 shares and buy the additional shares from the other investors, if someone wants to sell their RE, during the RE trading dates
- You can apply for the 6 shares and let the remaining 4 shares lapse. (6 & 4 are just random numbers).
- You can apply for the 6 shares and sell the remaining 4 shares during the RE trading dates.
- You can let all 10 rights shares lapse which is ignoring the RE fully. No action is required in this case.
- You can sell all 10 shares to the other investors during the RE trading dates.
- Renunciation of Rights Shares:
It is the process of renouncing or selling the REs to other investors, who want to buy the REs, at a better price than the issue price, as declared by the company, of the rights shares.
If someone follows as told in points (5) and (7), you can say that he/she is renouncing the rights shares as he/she is selling the shares to other investors. Point (3) will not be considered as the example of renunciation of rights shares as here you are buying shares instead of selling them.
- Rights Issue Renouncee:
The person who buys REs in the renunciation process by paying a price, higher than the issue price, for the shares purchased from the seller who is not willing to subscribe to his rights entitlement is known as ‘Renouncee’.
When a company announce a rights issue, the share price, generally, goes down post-issue due to the increment of outstanding shares in the stock market. Well, you can’t derive the exact price post the rights issue as you do in a stock split and bonus issue.
But, you can get the theoretical share price after the rights issue by using a mathematical formula and the derived price is known as TERP (theoretical ex-rights price).
For example, let’s say, a company announces a rights issue in the ratio of 1:10 i.e. 1 share for every 10 shares held, at an issue price of Rs 150. You have 100 shares of that company and the current market price is Rs 200. Based on this, the TERP can be derived as per below to estimate a rough share price after the rights issue.
TERP = (10*150) + (100*200) / 110 = 21,500 / 110 = 195.4
The shares can be expected to trade around Rs 195.4 post-rights issue which is less than the current market price before the rights issue which was Rs 200.
Investors, who want to participate in the rights issue, can apply online or offline using the ASBA (Application Supported by Blocked Amount) facility or the R-WAP (Registrar’s Web-based Application Platform) facility
1. Application through the ASBA process:
If you are applying through the ASBA process for the first time, then make sure that your bank is an SCSB (Self-certified syndicate bank; It is a bank which offers the facility of applying in public issue i.e. IPO & FPO and Rights Issue through ASBA process). If your bank is an SCSB then convert your normal savings bank account to ASBA enabled bank account.
Firstly, download the application form from the website of SCSB, Registrar, Exchange, or Company. Then, fill it up and submit it, either physically or online, to SCSB
2. Application through the R-WAP process:
Go to the R-WAP, i.e. website of the registrar, and fill out the online application form available there.
Advantages & Disadvantages of Rights Issue
- It is the fastest way to raise capital for the company.
- A company can save advertising costs and underwriter fees as the rights issue is a low-cost affair for the company.
- The company can raise additional funds without worrying about the burden of debt and loans.
- The rights issue allows the existing shareholders to increase their stake in the company at a price less than the current market price.
- A rights issue is a way to retain control over the company by the existing shareholders as it is subscribed by the existing shareholders and not by some outsiders.
- As the number of outstanding shares in the share market increase, it can lead to the dilution of existing shareholding.
- Post-rights issue, the share price gets decreased.
- A rights issue can create a negative impact on the company’s public image as people
- As the number of outstanding shares in the share market increase, it can lead to the dilution of existing shareholding.
- Post-rights issue, the share price gets decreased.
- A rights issue can create a negative impact on the company’s public image as sometimes it is a sign of a liquidity crisis that a company is suffering.
Conclusion
A rights issue is a voluntary corporate action that is about raising share capital from existing shareholders by offering them shares. The rights issue of shares can be paid in full or in part.
If an applicant is required to pay the entire issue amount, it is a fully paid rights issue and if one needs to pay only a partial amount as application money, then it is a partly paid rights issue.
One can apply in a rights issue either through an ASBA process or through an R-WAP facility. One should know the reason, why a company is raising capital by issuing rights shares as the rights issue has its benefits and also disadvantages.
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