What will a company do if they need extra funds to expand their business? They can either apply for a bank loan, issue debt or issue some fresh equity.

If they wish to raise fresh capital without adding liabilities on their balance sheet, issuing fresh equity is their best option. There are four ways in which a listed company can raise additional funds from the primary market:

Private Placement:

A company offers its securities to a small selected group of investors. These can either be institutions or individuals, or both.

Preferential Issue:

This is the fastest way for a company to raise capital.

The difference between Private Placement and Preferential Issues is that private placement is the issuance of shares to private investors and not to the general public. The preferential issue is the process of issuing shares to selected people based on criteria set by the company.

Rights Issue:

This is issued when a company wants to raise more capital from existing shareholders. It is done by offering them more shares at a discounted rate from the market price. The number of shares offered is on a pro-rata basis.

In this article, let’s focus on why companies do rights issue and its advantages for investors.

What is Rights Issue?

A rights issue is an invitation to existing shareholders to buy more shares at a discounted price. Shareholders need to apply for rights issue before the record date. It is also known as the cut-off date.

Existing shareholders have rights but no obligation to buy these shares. However, this gives them an opportunity to increase their stake within the company.

The primary reason why companies do rights issue is to raise money. This does not mean that the company is incurring losses and hence is in need of capital.

Rights are issued for various reasons like –

1. Business Expansion or Acquisition

Funds are needed when a company plans to grow its business. Raising fresh capital gives them an opportunity to offer a diverse range of services.

Many companies did rights issue during the Covid-19 pandemic. This includes companies with strong fundamentals like L&T Finance Holdings Limited, Tata Power, etc. These companies have raised more than Rs. 10,000 crores through rights issue during the pandemic.

2. Become Debt-Free

Reliance Industries opted for a rights issue in 2020 to become debt-free. The company used the net proceeds towards repayment of their borrowings.

They successfully closed their rights issue at Rs. 53,124 crores on June 3, 2020. This was India’s largest-ever rights issue. It is also the world’s largest rights issue by a non-financial institution in the last ten years.

Different types of Rights Issues:

1. Renounceable Rights Issue

The shareholder has the option to buy the shares by exercising their right or ignore the right. They can also sell or transfer their rights to other investors in an open market.

2. Non-Renounceable Rights Issue

The shareholder cannot sell his/her rights to another investor. They only have the option to either exercise the right or give it up.

Understanding with an example – Reliance Industries Rights Issue

Reliance Industries Limited had issued rights in May 2020. Here are the details of the rights issued –

Reliance Industries rights issue price was set at ₹1,257 per share. The issue size was of 42.26 crores equity shares aggregating upto ₹53,125 crores. For every 15 shares help, a shareholder can buy one share at the discounted price.

The rights were issued at a discount of ₹200 to its share price for existing shareholders (₹1,458.90 – ₹1,257).

Anyone having Reliance Industries in their demat account by 14^th May (the record date), can apply for rights issues between May 20th and June 3rd, 2020.

Existing shareholders have three options –

1. They can choose to buy the right shares:

This is what the company expects while raising fresh capital. A significant amount of funds are raised by resorting to this method.

2. They can choose to ignore the right issue shares:

If the company isn’t doing well, ignoring the rights issue might be the right thing to do. Investing in a financially poor company is always a risky bet. Do not be lured by the discounts. Do your own research before investing in any company.

For example, PVR Limited issued rights in July 2020. The proceeds will be essentially used for meeting working capital needs and partly for debt repayment. They have approximately Rs. 150 crores od debt repayment due.

Theatres in India have been shut for over five months due to Covid-19 led lockdown. This pauses their operations and directly hits their revenue income. If you think this to be a risky investment, then you have an option to ignore and let go of your rights.

3. They can choose to sell them off:

Shareholders who are not interested in the rights issue, can sell their rights in the open market. This is also known as the renunciation of rights issued. This way, the shareholder can make profits on the shares and the company will also be able to raise the required capital.

Rights Issue Benefits:

The rights issue offers several benefits to the company as well as the shareholder.

Benefits for the company –

1. Rights issue is one of the fastest methods for a company to raise fresh capital from their existing shareholders. The company needs to hold a board meeting and pass resolution for issuance of shares under Rights Issue.
2. They incur lower issue costs and save on various expenses like advertising, underwriting fees, etc.
3. This is the best way to raise funds without increasing the debt burden.

The confidence of the existing shareholders is retained by making such discounted offers.

Benefits for the Shareholders –

Rights Issue provides existing shareholders an opportunity to increase their stake at a discounted price.

Shareholders are considered to be the owners of a company. The number of shares owned by them determines their ownership. Since this offer is made to the existing shareholders, they continue to hold the authority in the company.

Rights Issue Disadvantages:

Rights issue leads to dilution in the value of holdings of the existing shareholders. Let’s understand this with the help of an example.

Scenario A:

Raj invites 10 people to his birthday party. They cut the cake equally in 10 pieces.

Scenario B:

Raj invites 20 people to his birthday party. They cut the same cake (same size) equally in 20 pieces.

In both the cases, everyone gets a piece of the cake. But the piece of cake will be bigger in scenario A than scenario B.

This is because the cake was divided between 20 people in scenario B.

Similarly, when the number of outstanding shares increases, your holding proportion dilutes.

This also impacts the Earnings Per Share (EPS) of the company. It is calculated as a company’s profit divided by the outstanding number of shares. It indicates how much profit a company is earning per shareholder.

How to apply for Rights Issue in India?

It can be applied online or offline using –

1. Applications Supported by Blocked Amount (ASBA) facility
2. Registrar’s Web-based Application Platform (R-WAP) facility.

The Securities and Exchange Board of India (SEBI) recently introduced the R-WAP facility. It is a temporary arrangement to ease the process of application in these pandemic times.

Making an application through ASBA process –

Investors must have an ASBA enabled bank account with a Self-Certified Syndicate Banks (SCSB). The process is similar to applying for an IPO.

The application form is available on the company’s website, Bombay Stock Exchange (BSE), National Stock Exchange (NSE), and registrar’s website.

If the form is not accessible, applicants can apply on plain paper. However, this would restrict investors from renouncing their rights issue.

a. Login to your account and select e-Services on the menu bar.

b. Click on DEMAT & ASBA Services.

c. Under the ASBA services (IPO), click on IPO (Equity). This is where you will find your rights application option.

d. Enter the details asked, such as your PAN, DEMAT number, select the depository, and enter the number of shares you want to apply for, etc.

Making an application through R-WAP process

Investors are required to have an active internet banking account or UPI facility.

They can then fill the online application form available on R-WAP. This facility is only for resident investors.

One important thing to remember is that the payment should not be done using a third-party account while using R-WAP. Here is SEBI’s guide on how to apply using R-WAP –

Source: BSE India, How to Invest in Rights Issue

Application on plain paper is not allowed through the R-WAP facility.

Rights Issues by Companies in 2021:

End Note:

In a nutshell, rights issue is a well-established method of raising funds. The issue helps the company to carry on their operations in a debt-free manner.

This method is adopted by the companies due to the ease of raising funds. They only need the Board of Directors’ approval for rights issue. This has been particularly popular during the COVID-19 environment.

However, the shareholders should not get greedy looking at the discounted price. Check the company’s performance and their aim behind the rights issue. It is very important to read the purpose of the rights issue before applying for it.

Here is L&T Finance Holding’s objective to why they issued rights-

It is a positive sign if the promoters take part in the rights issue. It suggests that they themselves believe in the purpose to issue rights.

Once your order for the rights is placed, the order amount will get blocked in your account. If the shares are not allotted to you, the amount will be unblocked and you will be able to withdraw the funds. So, plan your liquidity needs accordingly.

Remember, to take part in rights issue, you must have the shares in your by the record date. Open a FREE DEMAT account with Samco to take complete benefit of the investing world.