Author: Jim Riley Last updated: Sunday 23 September, 2012
Share capital - rights issues
What is a rights issue?
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
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
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:
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
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
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
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 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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