Rights Issue – Why is it Important to Shareholders?

Investments activities in the stock market are in full swing these days. But some of these activities are being done behind the curtains and have no link with the general public.

Simply put, Right Issue – which has long been a popular corporate segment, is widely used by many companies in India.

Based on the Right Issue of shares, companies fulfill their funding requirements for business expansion while assuring their existing shareholders of maximum benefits and the highest return exposure.

Still, if you have some doubts surrounding ‘Right Issue,’ we recommend having your eyes on this article. Here’s a detailed overview of the right issues and how it is so important to shareholders.

Understanding the Right Issue

As the name describes, ‘Right Issue’ is a process by which a company can offer certain of its rights to someone against their significant contribution to the company.

But the actual meaning of ‘Right Issue’ can vary from industry to industry. Such as, in the financial market, the Right Issue can be described in this way.

Unlike standard stock market purchasing or IPO investment, where anybody can purchase a company’s shares, the right issue is an invitation sent to the existing shareholder only and allowing them to purchase more new shares of the company.

And to ensure that existing shareholders are convinced to purchase these shares, the company offers them a discounted price that may be lower than the general market price.

If the existing shareholder is convinced, they can acquire more stakes in the company besides their existing holdings direct from the owner rather than buying from a brokerage firm or public market.

However, throughout the share transfer process, the shareowner retains the right at what amount they are ready to issue the company’s share.

A total number of shares to be transferred against a specific price to the existing shareholders is discussed between both parties.

How does Rights Issue work?

This walkthrough has clarified what the ‘Right Issue’ is, but it is still interesting to see how this unique corporate process happens in real life. So without further ado, let’s discuss.

‘Right Issue’ is mainly a fund-raising strategy many companies in India adopt. Through this approach, the company offers a discounted value of its share to its existing shareholders to lure them and make them fulfill the company’s funding requirement.

But this offer doesn’t last that long. The offer is expired as soon as an existing shareholder acquires more additional stake in the company.

Also, the proportion of issued shares is decided by the existing shareholdings in the company of the partners.  Ultimately, the eligible shareholder wins the deal and acquires the company’s share at a discounted share price.

It’s worth noting that this shareholder can even transfer their rights entitlements to another person without the company’s and its partners’ consent.

What are Right Entitlements?

Unsurprisingly, confusion can arrive if the company has multiple shareholders rather than just two or three. So this is where the Right Entitlements come to their rescue.

The process comprises issuing new shares to the eligible candidates as per the ratio of their existing shareholdings. However, certain conditions related to Rights Entitlement must be met.

As per new SEBI guidelines, companies must credit the Right Issue Entitlement directly to the shareholder’s Demat account. Other conditions need to be met as well.

It is equally mandatory for shareholders to evaluate the company’s performance before acquiring more shares in the company. But if you refuse this offer, you may make a big mistake.

Why Must Shareholders Consider Right Issues?

Here comes the most important topic, ‘why shareholders must consider Right Issues’ because we have a reason to disclose the positive sides of it.

Expansion of the Portfolio & Return

One of the most prominent benefits driven by Right Issue is exposure to maximum returns.

Suppose you are sensing potential in the company and believe that, sooner or later, the company is expected to outpace everyone in the industry. In that case,n you are likely to expand your portfolio.

And the best thing is that you will stay even more profitable since you are now acquiring the company’s share at a discounted price. Thus, the return on investment can be miraculously higher.

Building a Safer Investment

You aren’t making any mistake by accepting the company’s invitation for the Rights Issue. If the company’s business model is unique and profitable, it will survive in the long run.

So what if the company isn’t doing well in the industry now. In the future, it can surely win the crowd, and the outcomes will be enjoyed by the shareholders who supported the company at their lows.

Simply put, you are more likely to weaken the company’s strength by ignoring the offer for the Rights Issue. Perhaps the funding will save it from the drowning period or let it launch a game-changing product in the industry.

So make sure by not being convinced for Right Issue, you are likely to put your existing holdings at risk.

Transfer Benefits

Any time in the future, Shareholders retain the right to transfer their holdings to someone or sell their share purchased through ‘right issue’ at a discounted price to any other individual.

The action is helpful in most cases when resolution is needed for certain conditions.

Another major benefit of acquiring more shares through Right Issue in the company is that in addition to shareholders, a company can also offer an issue to employees or any other person outside the company.

Simply put, the company can offer the issue to employees under ESOP (Employee Stock Option Plan) to find a special resolution to a specific conflict within the organization.

Alternatively, they can pass a special resolution for an individual outside the organization by issuing shares to these people in the company.

Such steps are taken to build a peaceful environment inside the organization or to deploy some strategic executions.

Example of Right Issues

Let’s assume Jackson is an investor and owns 100 shares of ABC Ltd. The shares of the company are trading at Rs 10 each. But soon after a few months, the company announced a rights issue that was being offered in the ratio of 2 for 5.

Simply put, each investor holding five company shares will now be eligible to buy two new shares.

To make sure all investors are convinced, the company allows a discounted price with the two newly issued shares, i.g., Rs 6 per share, which is a fairly great deal for an investor.

Similarly, Jackson- the company’s existing shareholder – will now have two additional shares in his portfolio at half of the value of what the share currently has in the market.

Also, five shares (at Rs 10 each) held by each existing company shareholder will access two additional shares at a discounted price of Rs 6.

Let’s understand the Right Issues through a real-life example –

Recently Bharti Airtel announced its Right Issue. The company wanted to raise Rs 21,000 crore to roll out 5G services, fiber plans, and data centers to accelerate growth in the company’s revenue stream.

It is one of the best suiting cases of Right Issue that genuinely helped a company achieve its goal.

Knowing the Pluses and Minuses of Right Issues

Mentioned below is a breakdown of major pluses and minuses of Right Issues. If you are also about to show interest in them, ensure you have these few things noted.

Why Right Issue?

The shareholders receive a lower price on the shares. Therefore, it builds a chance for current shareholders to grow their holdings at a cheaper cost and make more when the share price increases.

The right issue is one of the finest ways for any organization to acquire money without even taking more debt from financial firms or banks that invites high-interest rates and terms and conditions to extend the burden on the company. Similarly, shareholders can also feel safe with their existing investments.

Why not Right Issue?

A company may not reach its goal if the shareholder rejects the offer because the company will not have a flexible alternative to meet its funding requirements.

If the company is fulfilling a big portion of its funding requirements via Right Issue shares, it will indicate a negative company profile. It is considered that the business is having difficulty maintaining a smooth functioning.

Conclusion

Well, Right Issue has some equal benefits for the company as well as for the shareholders. After all, both parties rely on each other in the real world.

This gives us a solid reason to demonstrate the significance of the Rights Issue, unlike the traditional buying and selling shares via a broker or in the Public Market.

The shareowner himself can issue the right to these shares. But you should ascertain some precautions if you are also an investor of a company that recently offered you Rights Issue.