What is Right Issue? How Companies Offer Extra Shares to Existing Investors

When you invest in the stock market, you’ll encounter various corporate actions that can affect your holdings. One such action, often misunderstood but extremely important, is the right issue. If you’ve ever wondered about right issues and how they impact your investments, this comprehensive guide will walk you through everything you need to know—how they work, why companies use them, what they mean for you as a shareholder, and how to make the best decision when you receive a right issue offer.

Right Issues Explained: The Basics

It is a method by which a company offers additional shares to its existing shareholders, usually at a price lower than the current market value. The offer is made in proportion to the number of shares each shareholder already owns. This means you get the “right” (but not the obligation) to buy more shares in line with your current stake.

Right issues are a way for companies to raise additional capital efficiently. Instead of borrowing money or bringing in new investors, the company gives its loyal shareholders the first opportunity to invest further in the business.

Example

Suppose you own 100 shares of a company. The company announces a right issue in the ratio of 1:5 at ₹80 per share, while the current market price is ₹100. This means you can buy 20 new shares (100 ÷ 5) at the discounted price of ₹80 each, if you choose to participate.

Why Do Companies Issue Rights?

Understanding this also means understanding the reasons companies choose this route. Here are some of the most common reasons:

1. Raising Capital for Growth Companies often need funds to expand operations, launch new products, or enter new markets. A right issue is a quick and effective way to raise capital from existing investors.
2. Paying Down Debt If a company has accumulated significant debt, it may use a right issue to raise money and pay off loans, improving its financial health and reducing interest costs.
3. Funding Acquisitions Sometimes, companies use right issues to finance mergers or acquisitions, giving them the flexibility to pursue new opportunities.
4. Improving Liquidity A right issue can provide much-needed cash, especially when other funding options are limited or expensive.
5. Maintaining Shareholder Control By offering shares first to existing shareholders, companies can raise funds without diluting the control of current investors.
6. Addressing Regulatory Requirements Some companies may need to meet certain capital adequacy norms or regulatory requirements, and a right issue can help them achieve this.

How Does a Right Issue Work? Step-by-Step

Let’s break down the process of a right issue:

1. Board Approval and Announcement The company’s board of directors approves the right issue and announces the details, including the offer price, ratio (e.g., 1 new share for every 5 held), record date, and subscription period.
2. Record Date Shareholders who own shares as of the record date are eligible to participate in the right issue. This ensures only current investors get the benefit.
3. Right Entitlement Each eligible shareholder receives the right to buy a certain number of new shares in proportion to their existing holdings.
4. Offer Price The new shares are typically offered at a price lower than the prevailing market price, making the offer attractive.
5. Trading of Rights (if permitted) In many markets, rights are tradable. If you don’t want to buy more shares, you can sell your rights to someone else in the market.
6. Subscription Period Shareholders have a limited window (usually 2–4 weeks) to decide whether to exercise their rights, sell them, or let them lapse.
7. Allotment and Listing After the subscription period, the company allots new shares to participating shareholders and lists them on the stock exchange.

Key Terms in Right Issues

To fully understand this, it helps to know these terms:

• Record Date: The cut-off date to determine eligible shareholders.

• Ex-Right Date: The date from which shares are traded without the right to participate in the right issue.

• Right Entitlement: The number of new shares you can buy, based on your current holdings.

• Subscription Price: The price at which new shares are offered.

• Renounceable Rights: Rights that can be sold or transferred.

• Non-Renounceable Rights: Rights that cannot be sold; you can only exercise them or let them lapse.

Types of Right Issues

1. Renounceable Right Issue Shareholders can sell their rights to others in the market. This adds flexibility and allows investors who don’t want to invest more to still benefit.
2. Non-Renounceable Right Issue Rights cannot be sold or transferred. Shareholders must either exercise their rights or let them expire.

Advantages of Right Issues

1. Shareholder-Friendly Existing shareholders get the first opportunity to buy additional shares at a discount, protecting their ownership from dilution.
2. Cost-Effective for Companies A right issue is usually less expensive and faster than a public offering, as it targets existing investors.
3. Raises Capital Without New Debt Companies can raise funds without increasing their debt burden or paying interest.
4. Flexibility Shareholders can choose to participate, sell their rights (if renounceable), or do nothing.
5. Potential for Profit If the subscription price is much lower than the market price, shareholders can benefit by buying discounted shares or selling their rights.

Disadvantages of Right Issues

1. Dilution Risk If you don’t participate in the right issue, your ownership percentage in the company will decrease.
2. Share Price Adjustment After a right issue, the share price may drop to reflect the increase in the number of shares and the discounted price.
3. No Guarantee of Success If not enough shareholders participate, the company may not raise the intended amount.
4. Perception of Weakness Frequent right issues may signal financial trouble, making investors wary.

Impact on Shareholders

For shareholders, a right issue is an opportunity but also a decision point:

• Participate: Buy more shares at a discount and maintain your ownership percentage.

• Sell Rights: If renounceable, you can sell your rights and potentially make a profit.

• Do Nothing: If you ignore the offer, your stake in the company will be diluted.

How to Decide Whether to Participate

Before acting on a right issue, consider these factors:

• Company’s Purpose: Why is the company raising funds? Is it for growth or to cover losses?

• Financial Health: Is the company fundamentally strong?

• Subscription Price: How much lower is the right issue price compared to the market price?

• Your Investment Goals: Do you want to increase your exposure to the company?

• Market Sentiment: How are other investors reacting?

How to Apply for a Right Issue

1. Check Your Eligibility: Make sure you are a shareholder as of the record date.
2. Review the Offer: Read the right issue letter for terms and conditions.
3. Decide Your Action: Exercise your rights, sell them, or let them lapse.
4. Apply via Broker or Online: Use your demat account or broker’s platform to apply.
5. Payment: Pay for the shares you wish to subscribe to.
6. Allotment: After the subscription period, new shares are credited to your demat account.

Real-Life Example: Reliance Industries Right Issue (2020)

Reliance Industries Limited (RIL) launched India’s largest-ever right issue in 2020, raising ₹53,124 crore. The company offered shares in a 1:15 ratio at ₹1,257 per share, a significant discount to the prevailing market price. The right issue was fully subscribed, showing strong investor confidence.

Tax Implications of Right Issues

• No Tax on Receiving Rights: Getting rights is not a taxable event.

• Tax on Sale of Rights: If you sell your rights entitlement, the profit is taxable as capital gains.

• Tax on Sale of Shares: When you sell shares acquired via right issue, capital gains tax applies based on your holding period.

Common Myths About Right Issues

Myth 1: Right Issues Are Always Bad News Fact: While some companies use right issues during tough times, many strong companies use them for growth and expansion.

Myth 2: You Must Participate Fact: Participation is optional. You can sell your rights or do nothing.

Myth 3: Right Issues Always Dilute Value Fact: If you participate, your ownership percentage remains the same, and you may benefit from the discounted price.

Frequently Asked Questions

Are right issues good or bad for shareholders? It depends on the company’s reasons for raising funds and how the capital will be used. If used for growth, it can be positive; if to cover losses, be cautious.

Do I have to buy the shares in a right issue? No, you are not obligated to buy. You can sell your rights (if renounceable) or let them lapse.

What happens if I ignore a right issue? Your ownership percentage in the company will decrease as new shares are issued to others.

Can I sell my rights entitlement? Yes, if the right issue is renounceable, you can sell your rights in the market.

What Happens to Share Price After a Right Issue?

After a right issue, the share price typically adjusts downward to reflect the increased number of shares and the discounted issue price. This is a natural consequence of dilution. However, if the company uses the new capital wisely, the long-term impact can be positive, potentially leading to higher profits and share prices in the future.

Right Issue vs. Bonus Issue

A right issue and a bonus issue are both ways companies issue new shares, but they are fundamentally different:

• Right Issue: Shareholders pay money to buy new shares at a discounted price.

• Bonus Issue: Shareholders receive additional shares for free, usually from the company’s profits or reserves.

A right issue raises new capital for the company, while a bonus issue does not.

Right Issue vs. Follow-on Public Offer (FPO)

• Right Issue: Only existing shareholders are eligible to participate, usually at a discount.

• FPO: Shares are offered to the general public, not just existing shareholders, and may or may not be at a discount.

What Should You Consider Before Participating?

• Company’s Track Record: Is the company using the funds for productive purposes?

• Discount Offered: Is the right issue price attractive compared to the current market price?

• Dilution Risk: Will not participating significantly reduce your ownership?

• Future Prospects: Does the company have a solid plan for growth or recovery?

• Personal Financial Situation: Can you afford to invest more in the company?

How to Make the Most of a Right Issues

• Act Quickly: It have a limited subscription window.

• Do Your Homework: Analyze the company’s financials and the purpose of the right issue.

• Consult a Financial Advisor: If unsure, seek professional advice before making a decision.

• Monitor Market Sentiment: Sometimes, the market’s reaction can provide clues about the right issue’s prospects.

Final Thoughts

A right issue is a corporate action that allows companies to raise capital by offering extra shares to existing shareholders, usually at a discount. For investors, it’s both an opportunity and a decision point. You can buy more shares at a favorable price, sell your rights, or let them lapse. The key is to evaluate the company’s motives, your own financial goals, and the potential risks and rewards before participating.

Right issues are a powerful tool for companies to strengthen their finances and for investors to potentially benefit from discounted shares. By understanding how right issues work, you can make smarter investment decisions and avoid common pitfalls in the stock market.