What is Right Issue?

What is Right Issue?

Right Issue is made by the company when they really need funds. Right issue is made to the existing shareholders, but there is no obligation on the existing investors to buy shares. This right issue is made on discount, means the investor can buy new shares at a discount to the current trading price.

Meaning: -

Right issue means a company is giving a shareholder a chance to increase their investment to the stock at a discount price. It is an invitation to the existing shareholders to purchase additional new shares in the company. This type of issue gives existing shareholders securities called rights. With the rights, the shareholder can purchase new shares at a discount to the market price on a stated future date.

Reasons for issue of Right shares: -

Companies bring right issue to raise additional capital in the company. This issue of right shares is done for extra capital to meet its current financial obligations. Companies typically use right issues to pay down debt, especially when they are unable to borrow more money. Companies with healthy balance sheets might also raise money through a right issue to acquire a competitor or open new facilities. For a shareholder, this can create capital gains. 

Not all companies which issues right shares are financially troubled. Some companies having a healthy balance sheet may use a right issue. This issue might be for a business expansion, to spend expenses for acquisition or opening new facilities for manufacturing or sales.

What is the effect on the company and what if a shareholder does not exercise his right?

A right issue affects two important elements of a company equity capital and market capitalization. In case of a rights issue, since additional equity is raised, the issuing company’s equity base rises to the extent of the issue. The effect on m-cap depends on the perception of the market. In theory, every new issue has some kind of diluting effect and hence as a result of a fall in the market price in proportion to an increase in the number of shares, the market capitalization remains unaffected. However, if the market sentiment believes that the funds are being raised for an extremely positive purpose then price of the stock may just rise resulting in an increase in the market capitalization.

Example: – 1:4 rights issue means an existing investor can buy one extra share for every four shares already held by him/her. Usually the price at which the new shares are issued by way of rights issue is less than the prevailing market price of the stock, i.e. the shares are offered at a discount.

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