A rights offering is a group of rights offered to existing shareholders to purchase additional stock shares, known as subscription warrants, in proportion to their existing holdings. Rights are often transferable, allowing the holder to sell them in the open market.
A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. More specifically, this type of issue gives existing shareholders securities called “rights,” which give the shareholders the right to purchase new shares at a discount to the market price on a stated future date.
Why Would a Company Issue a Rights Offering?
Companies most commonly issue a rights offering to raise additional capital. A company may need extra capital to meet its current financial obligations. Troubled companies typically use rights issues to pay down debt, especially when they are unable to borrow more money. The rights issued to a shareholder have value, thus compensating current shareholders for the future dilution of the value of their existing shares.
However, not all companies that pursue rights offerings are in financial trouble. Even companies with clean balance sheets may use rights issues to raise extra capital to fund expenditures designed to expand the company’s business, such as acquisitions or opening new facilities for manufacturing or sales. If the company is using the extra capital to fund expansion, it can eventually lead to increased capital gains for shareholders despite the dilution of the outstanding shares, as a result of the rights offering.
How Rights Issues Work
So, how do rights issues work? The best way to explain this is by using an example from Investopedia:
Let’s say you own 1,000 shares in Wobble Telecom, each of which is worth $5.50. The company is in financial trouble and needs to raise cash to cover its debt obligations. Wobble, therefore, announces a rights offering, in which it plans to raise $30 million by issuing 10 million shares to existing investors at a price of $3 each. But this issue is a three-for-10 rights issue. In other words, for every 10 shares you hold, Wobble is offering you another three at a deeply discounted price of $3. This price is 45% less than the $5.50 price at which Wobble stock trades.
The shareholder would have three options with a rights issue: (1) subscribing to the rights issue in full, (2) ignoring the rights or (3) sell the rights to someone else.