How Right Issues Affect Your Investment

A right issue is also known as a right offer and it can be defined as the rights that are offered to a company’s existing shareholders to buy additional shares in proportion to their existing holdings.

Still considering how corporate actions taken by the management of a company affects the investor, the right issue is one popular action that is noteworthy.

A right issue is also known as a right offer and it can be defined as the rights that are offered to a company’s existing shareholders to buy additional shares in proportion to their existing holdings.

These rights are referred to as subscription warrants or rights and they are given to existing shareholders as a way to raise capital without overly increasing the number of shareholders.

However, it isn’t compulsory for the investor to take on the right. In fact, the definition many of us are used to probably says that the right issue is, “a situation where shareholders/ investors are given the right, but not the obligation, to purchase additional shares of a company at a specified future date.”

In other words, right issue is a type of option given to shareholders with three possible courses of action available for them: Do not exercise your right to buy additional shares, buy a portion or all of the new shares that you have been given the right to purchase, or transfer (sell) those rights on the open market.

Right issues are used proportionately so the number of additional shares an investor can buy, largely depends on its existing shareholdings.

The first clear benefit is that the price the shares are given at which is known as the subscription price, is give at a discount in relation to the prevailing market price. Hence, a current investor buys it at a lower price.

Even better is that such rights are transferable, so the holder has the opportunity to sell them in the open market. This means that after accepting the right, instead of being overweight on the stock, the investor can sell the shares in the market and make some quick gains.

Just like all other corporate actions, there are rationales behind right issues. For the company, it is a way to raise money.

However, where a company wants to ordinarily increase the number of shares it is issuing, the shares of the existing shareholders would be diluted – worth less than it should be as there are now more shareholders.

As such, right issues are offered at a discount to investors as a way to compensate the existing shareholders for the expected dilution of their shares.

A clear benefit for investors is that they can skip the cost of investing.

In other words, they would not need to pay underwriting fees and other transaction costs. There is also the direct cost benefit from the discount given.

The risks are that, first, the shares of the company would not be diluted. Also, investors who already had plenty shares and still take part of the rights issue may now have too many shares and now be too concentrated.

If you choose not to, your shares would be diluted and you would have less ownership in the company. A rights issue might also be an indicator that the company has issues preventing it from raising capital internally.

It could have a debt problem or some other issues that affects its liquidity. As such, before you take on the opportunity as an investor, a little bit of evaluation would be required.

Written by Lawretta Egba.