What is Rights Issue Offering?

Rights Issue is one of the many ways in which a company raises capital by issuing new equity shares. Unlike other means of raising capital, in a rights issue, new shares must be offered to the existing shareholders of the company in proportion to their holding on the date on which the offering is made.

The underlying principle here is that when raising more capital, the company gives preference to its existing shareholders so that none of them are disadvantaged by way of any dilution in their percentage holding in the company. It is like raising new capital from the existing owners of the company.

No Shareholder Approval Needed for Rights Issue

Since a rights issue does not bring in new owners/ shareholders into the company, no shareholder approval is needed to offer rights shares. An approval of the board of directors is enough. For the same reason, a company can issue rights shares at any price- higher or lower than the market price of the shares.

Advantages of Rights Issues over other methods of raising capital

[1] Raising Money the Easy Way – Unlike an initial public offering and a follow on public offering, rights issues have less stringent formalities. In essence, rights issues are considered as an internal matter of the company since the offering is made only to the current shareholders. Listed companies must file a letter of offer with SEBI and with stock exchanges for public comments and approval by the exchanges before they allot new shares. Unless any shareholder or group of shareholders are being disadvantaged, rights issues do not bother the regulators much.

[2] Expansion without Debt – Think about it, if a company can manage to raise the required capital from its existing shareholders without changing a thing in terms of percentage holdings of anyone, why would it then chose debt?

Also read: Why companies prefer taking debt over equity.

[3] Rights Issue to Increase Promoter Shareholding

– An ancillary benefit of doing a rights issue is that promoters can increase their shareholding in the company by subscribing to the ‘unsubscribed portion’ of the issue.

Many shareholders fail to subscribe to their rights entitlement either because of legal formalities with regard to filling up the Common Application Form (CAF) in time, or because they do not have readily available cash to subscribe when the offering is made. While shareholders are allowed to renounce their entitlement in favour of anyone else, mostly no one makes the effort to do that.

Shareholders who do not subscribe to their rights entitlements and who do not renounce in favour of anyone, have their entitlement fall into the ‘unsubscribed portion’ category. As per the terms of the letter of offer sent to the shareholders, promoters typically reserve the right to subscribe to this unsubscribed portion. This helps them increase their shareholding, albeit marginally (also see Subscribing and Renunciation below).

Record Date and Pricing of Rights Issue in India

The company has to announce a record date for the purpose of determining shareholders who are eligible to participate in the rights issue just like it announces the record date for the purpose of dividends.

What makes a rights issue really attractive for companies is the fact that they can issue the rights shares at any price. Unlike in case of qualified institutional placement where SEBI has an elaborate pricing formula, rights shares can be issued at any price which the board decides.

Naturally the company will issue rights shares at a discount, not only to reward its existing shareholders but also to make sure that it is able to get maximum subscriptions and is able to raise the required capital.

Subscribing and Renouncing Your Rights Entitlement

Every shareholder of the company is entitled to subscribe to his rights shares which are always in proportion to his/ her shareholding in the company.

Shareholders will get a Common Application Form (CAF) at their address registered with the company (note: companies use the address which you have on the record with your depository participant or share broker). Shareholders must fill in the relevant details on this CAF and deposit the same with a collection bank.

Relevant details: In the CAF, shareholder must specify the extent to which they wish to apply for their entitlements.

For example, in January 2015, Tata Motors issued rights shares in the ratio of 6:109, i.e. for every 109 shares, the shareholder were entitled to get 6 rights shares. Assuming that a shareholder held 1000 shares on the record date, he would be entitled to 55 rights shares (calculated as 6/109*1000). The CAF he would have received would state this fact and have the below language:

“ . . . . I wish to apply for ____ rights shares….”

Where the shareholder could fill in the details with regard to the number of share he wishes to apply for.

In the above case, assuming that the shareholder wants to apply for 50 shares, he would fill in ‘50’ in the blank space above and make a cheque payable to the specified bank account of Tata Motors and deposit the form and the check to a designated bank branch. The amount of the cheque will be based on the price at which the rights shares are being offered which is usually below the trading / market price of the share. In this case the shareholder will be allotted only 50 shares and his balance entitlement of 5 shares will fall in the ‘unsubscribed portion’.

If you have any questions with regard to any aspect of Rights Issues, feel free to contact me at – rajat@sanasecurities.com or just call me. My numbers are mentioned above.

Renunciation: The CAF has a column on renunciation. The shareholders can fill this column to renounce their entitlement in part or in full. In the above case, the shareholder may renounce 5 shares or the entire 55 share entitlement in favour of someone else.

If renounced, the shareholder simply needs to mention the name of the person in whose favour he renounces the entitlement and hand over the form to such person who then needs to fill in his details in the form to apply for shares.

Further, in addition to applying and/or renouncing to their rights entitlements, shareholders can also apply for additional shares over and above their entitlements. The allotment of additional shares is at the sole discretion of the management / board of directors. Typically this means that the board can decide the extent to which they would like a shareholder’s holding to increase.

Note: Since most companies will issue rights shares at a discount, it often creates a GREY MARKET to buy the rights entitlements. Brokers would want to buy the rights entitlements from any willing seller and would pay them some percentage of the discount i.e. the difference between the market price and price at which rights shares are being offered by the company.

To explain with an example, in 2014 when Indian hotels announced its Rights Issue at the price of Rs. 55 a share, the share was trading in open market around Rs. 90. Current shareholders could either pay Rs. 55 to subscribe to the rights shares – an immediate gain of Rs. 35; or they could renounce it in favour of someone else. Brokers were offering anything between Rs. 12-17 to get shareholders to renounce entitlements in their favour.

Collection Bank: The CAF will specify a list of all collection bank branches.

Plain Paper Application: Given that retail investors often miss out on applying due to the paperwork involved and for other complexities, SEBI insists that the merchant bankers handling the issue accept plain paper applications and try to help the shareholders as much as they can in allotting them with their entitlement shares.

You should call the company or the merchant banker handling the issue in case you do not receive your CAF or if for any reason you are not able to apply for your shares. In most cases merchant bankers will try to help you out.

Final Points

Before you apply in a rights issue, find out where the company plans to use the proceeds. The letter of offer which you will receive (also available on the websites of SEBI and Merchant bankers) will state this. Further, the letter of offer will also state other terms including the discount at which the offering is being made.

Make sure that the rights shares are being offered at a discount to the market price of the share; else you could buy the same number of shares from the open market at a cheaper price.

Also understand that your money will be blocked for a few days – from the date on which you submit the application to the designated bank for subscribing, until the day on which your rights shares are credited into your account.

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Rajat Sharma

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