As a new investor, you may come across terms in news reports or public filings that you’re not familiar with and still don’t completely understand after looking it up. This article is part of DollarsAndSense’s investor education series, which introduces and explains investment-related terms.
Today, we answer the question: What is a rights issue?
Definition of ‘Rights Issue’
A rights issue is a move by a company to grant the right to existing shareholders to purchase newly-created shares within a specified time period, usually at a discount to the current trading price. The proportion of new shares that shareholders can purchase is in proportion to their existing shareholdings.
Why Do Companies Perform Rights Issues
Companies generally offer rights when they need to raise money, perhaps to pay off debt, fund an acquisition, or invest in additional assets. It is one way of raising money without incurring additional debt.
What Happens During A Rights Issue
In response to a rights issue, shareholders can do one of the following:
– Choose not to exercise their right to purchase additional shares
– Buy a portion or all of the new shares they have a right to purchase
– If the rights are transferrable, shareholders can sell those rights on the open market
Impact Of A Rights Issue
A rights offer can be beneficial to shareholders because they can buy shares at a discounted price. However, for those shareholders who do not wish to pump in even more money to increase their exposure to the company, it will mean a dilution of their existing shareholdings.
The issuance of additional shares also mean that the company’s earnings per share (EPS) decreases, since there are more shares after a rights issue exercise.
Do Your Own Diligence
It might seem that having the option to buy additional shares in a company you’re already vested in is a good deal. But you should understand the company’s plan for spending the money raised, and evaluate what it means for the company’s future prospects before deciding what to do with your rights.
For example, a rights issue might raise funds to solve the problem of meeting the company’s debt obligations, but not solve the structural issues that lead to the company not being in a financial position to pay off its debts in the first place without raising additional money.
So now that you understand share buybacks better, what is another investing term you want us to cover next? Let us know on the DollarsAndSense Facebook Page!