equity finance - rights issues
Introduction
What is a rights issue?
A rights issue is an issue of new shares for cash to existing shareholders in proportion to their existing holdings.
A rights issue is, therefore, a way of raising new cash from shareholders - this is an important source of new equity funding for publicly quoted companies.
Why issue shares to existing shareholders?
Legally a rights issue must be made before a new issue to the public. This is because existing shareholders have the “right of first refusal” (otherwise known as a “preemption right”) on the new shares.
By taking these preemption rights up, existing shareholders can maintain their existing percentage holding in the company.
However, shareholders can, and often do, waive these rights, by selling them to others. Shareholders can also vote to rescind their preemption rights.
How are the shares sold in a rights issue priced?
The price at which the new shares are issued is generally much less than the prevailing market price for the shares. A discount of up to 20-30% is fairly common.
Why would a business offer new shares at a price well below the current share price?
The main reason is to make the offer relatively attractive to shareholders and encourage them either to take up their rights or sell them so the share issue is "fully subscribed".
The price discount also acts as a safeguard should the market price of the company's shares fall before the issue is completed. If the market share price were to fall below the rights issue price, the issue would not have much chance of being a success - since shareholders could buy the shares cheaper in the market than by taking up their rights to buy through the new issue.
Do existing shareholders have to take up their rights to buy new shares?
In a word - no.
Shareholders who do not wish to take up their rights may sell them on the stock market or via the firm making the rights issue, either to other existing shareholders or new shareholders. The buyer then has the right to take up the shares on the same basis as the seller
Other factors to consider in rights issues
In addition to the price at which a rights issue is offered, there are several other factors that need to be considered:
Issue Costs
Rights issues are a relatively cheap way of raising capital for a quoted company since the costs of preparing a brochure, underwriting commission or press advertising involved in a new issue of shares are largely avoided.
However, it still costs money to complete a rights issue. Issue costs are often estimated at around 4% on equity funds raised of around £2 million raised. However, as many of the costs of the rights issue are fixed (e.g. accountants and lawyers fees) the % cost falls as the sum raised increases.
Shareholder reactions
Shareholders may react badly to firms continually making rights issues as they are forced either to take up their rights or sell them. They may sell their shares in the company, driving down the market price
Control
Unless large numbers of existing shareholders sell their rights to new shareholders there should be little impact in terms of control of the business by existing shareholders
Unlisted companies
Unlisted companies often find rights issues difficult to use, because shareholders unable to raise sufficient funds to take up their rights may not have available the alternative of selling them where the firm's shares are not listed. This could mean that the firm is forced to rely on retained profits as the main source of equity, or seek to raise venture capital or take on debt.
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