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Rights Offering Issue Definition Types Pros and Cons

Rights Offering Issue Definition Types Pros and Cons

Rights Offering (Issue): Definition, Types, Pros, and Cons

What Is a Rights Offering (Issue)?

A rights offering (rights issue) offers existing shareholders the chance to purchase additional stock shares, called subscription warrants, in proportion to their existing holdings. This type of offering grants stockholders the right, but not the obligation, to buy more shares.

In a rights offering, the subscription price for each share is generally discounted compared to the current market price. Before payment, these shares are known as nil-paid shares and become fully paid once they are paid for. Rights can be transferred and sold in the open market.

Key Takeaways

  • A rights issue invites existing shareholders to purchase additional shares in the company.
  • In a rights offering, each shareholder receives the right to purchase additional shares at a specific price and within a specific period.
  • Shareholders are not obligated to exercise this right.
  • Rights offerings are used by cash-strapped companies to raise money.

Rights Offering

How a Rights Offering (Issue) Works

In a rights offering, each shareholder receives the right to purchase additional shares at a specific price and within a specific period. Shareholders are not obligated to exercise this right.

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A rights offering is an invitation to existing shareholders to purchase additional shares at a discount to the market price. Shareholders are given securities called "rights" that allow them to purchase new shares at the discounted price on a future date. This gives shareholders a chance to increase their exposure to the stock while obtaining it at a lower price.

Until the date when the new shares can be purchased, shareholders can trade the rights on the market like ordinary shares. The rights have value and compensate current shareholders for the future dilution of their existing shares’ value. Dilution happens because a rights offering spreads a company’s net profit over a larger number of shares, decreasing the company’s earnings per share (EPS).

Types of Rights Offerings

There are two types of rights offerings: direct rights offerings and insured/standby rights offerings.

  • In direct rights offerings, the issuer only sells the number of exercised shares, without standby/backstop purchasers. If not subscribed properly, the issuer may be undercapitalized.
  • Insured/standby rights offerings allow third parties/backstop purchasers (e.g. investment banks) to purchase unexercised rights. This type of agreement ensures the issuing company that their capital requirements will be met.

Rights issued can be non-renounceable or transferable, depending on the case.

Advantages and Disadvantages of Rights Offerings

Advantages

Companies use rights offerings to raise money for various purposes, including paying off debt, purchasing equipment, or acquiring another company. They can also be used when there are no other viable financing alternatives. Benefits for existing shareholders include the opportunity to purchase additional shares at a discount, bypassing underwriting fees, and increased market interest in the company’s stock.

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Disadvantages

Rights offerings can have disadvantages for the issuing company and existing shareholders. Shareholders may disapprove due to concerns about dilution, and the offering may result in more concentrated investor positions. The costs and procedures associated with the rights offering may outweigh the benefits for the issuing company.

Why Would a Company Do a Rights Offering?

The main reason for a rights offering is to raise capital for various purposes, such as business expansion or debt repayment. Offering rights to existing shareholders avoids the time-consuming and costly process of underwriting and releasing more shares to the public.

How Do Rights Offerings Affect a Company’s Stock Price?

Rights offerings dilute the value of existing shares due to the release of more shares. This can harm the stock price, especially if the offering is associated with financially struggling companies, which reduces investor confidence.

Do I Have to Purchase Stock Through a Rights Offering?

Existing shareholders are not obligated to purchase additional stock through a rights offering; it simply offers them the chance to do so.

The Bottom Line

Rights offerings are additional shares of company stock offered to existing shareholders on a non-obligatory basis. The shares are offered at a discount to incentivize shareholders to purchase stock. Companies issue rights offerings to raise capital for various reasons.

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