What is a rights issue and how does it work?
By Nairobi Stocks Review
Public companies have multiple ways to raise money if they need it. They could go to the banks for a loan or turn to their shareholders to put more money in the business. A rights issue, also called rights offering, is an example of a company going to its shareholders for more money.
From time to time, you may hear companies announcing rights issues. We will get to what is a rights issue and how it works in a moment. First, let’s see why a company might need to do a rights offering.
Usually, a company should be sustained by the profit it makes. But it doesn’t work that way all the time. Sometimes a company may need more money than comes in through profit.
For example, a company may want to raise more money to expand its operations, pay off debts, settle a lawsuit that carries a fine or acquire another company to diversify its business.
What is a rights issue and how does it work?
In a rights issue, a company makes new shares and sells them to existing shareholders. The result is that the shareholders get to own more shares in the company while the company receives the money.
To entice shareholders to participate in the issue, the company will sell the new shares at a discount to the current price of its stock on the Nairobi Securities Exchange. It means that if a company’s shares are currently trading for Ksh20, the company might price the rights issue shares at Ksh15.
That means that if you wanted to buy more shares in the company, it would be cheaper to participate in the rights issue than going through the open market.
Also, rights issue shares are transferable. For example, if you have been allocated 100,000 shares in a rights issue, you may decide to sell those shares to another investor. If you choose to sell the shares at Ksh18, you could make a profit of Ksh300,000.
Bear in mind that in a rights issue, shareholders are allocated shares based on their current stake in the company. Therefore, the more shares you currently own, the more rights issue shares you will receive.
Is a rights issue good or bad?
A rights issue has its consequences. It can affect a stock positively or negatively. If a company is doing a rights issue to invest, such as expanding its business or acquiring another business, it may affect the stock positively.
Investors will hope the company will make more profit in the future and its shares would be more valuable. In that case a rights issue could cause a company’s share price to rise on the stock market.
However, if a company is doing a rights issue because it has been making losses and has run out of money, then it could have an adverse impact on the stock. Investors might read that the company is struggling and not worth their money. In that case, the company might struggle to get shareholders to participate in the issue, which could result in it raising less money than it wanted.
Why would a company do a rights issue?
In conclusion, companies usually turn to rights issue if the other options to raise money such as borrowing from banks are not viable. When interest rates are high, for instance, borrowing becomes expensive. In that case, a company may decide to go to its shareholders for more money through a rights issue.