Rights issue: discounted new shares for existing holders

A rights issue is when a listed company asks existing shareholders to buy new shares, normally at a discount to the market price, to raise fresh equity. Each shareholder is offered the chance to subscribe in proportion to their current holding, so ownership can stay in line if they participate.

Shareholders typically receive tradable or non-tradable rights that give them the option to buy. If they take up the rights in full, their percentage holding should be maintained. If they do not, their stake is diluted because the total number of shares increases. A rights issue is a formal offer, not an obligation.

Why companies launch a rights issue

Companies use rights issues to raise capital for several reasons:

• Repairing the balance sheet by paying down debt or shoring up liquidity.
• Funding acquisitions or large projects that need equity alongside debt.
• Meeting regulatory capital or leverage requirements in sectors such as banking.
• Adding resilience after a setback that has strained cash flow.

Unlike a placing to new investors, a rights issue respects pre-emption for existing holders. The discount and the size of the raise reflect the company’s urgency, market appetite and the risk investors perceive.

How a rights issue works in practice

The mechanics follow a set sequence, although exact rules vary by country and exchange and can change:

1. Announcement. The company publishes terms such as the subscription price, the ratio of new shares to existing shares, the gross amount to be raised and whether the issue is underwritten.
2. Record date. Shareholders on the register at the close of business on the record date are entitled to receive rights.
3. Ex-rights date. From this date the existing shares trade without the entitlement. The share price typically adjusts down to reflect the forthcoming discounted shares.
4. Rights trading period. In a renounceable issue, rights are listed and can be bought or sold as separate securities, often called nil-paid rights. In a non-renounceable issue, rights cannot be traded.
5. Acceptance and payment. Shareholders who wish to take up the offer submit instructions and funds by the deadline. Some markets allow excess applications if other holders do not subscribe.
6. Allocation and dealing. New shares are allotted and start trading fully paid. Lapsed rights, if any, may be sold by the underwriter in a rump placing, with any net proceeds often distributed to non-participating holders according to local practice.

Underwriting is common. One or more banks agree to buy any shares not taken up, for a fee. This reduces the risk that the company raises less than planned.

The numbers: ratio, price, TERP and rights value

Two numbers define a rights issue: the ratio and the subscription price. The ratio tells you how many new shares you can buy for a given number of existing shares, for example 1-for-4. The subscription price is what you pay for each new share, usually set at a discount to help the deal succeed.

Analysts often use the theoretical ex-rights price, or TERP, as a guide to where the share might trade when it goes ex-rights. TERP blends the old price with the discounted new shares:

TERP = (Existing shares × Market price before rights + New shares × Subscription price) ÷ Total shares after the issue

Example: you own 1,000 shares priced at 200p. The company launches a 1-for-4 rights issue at 150p. You are entitled to buy 250 new shares at 150p. TERP is:

TERP = (4 × 200p + 1 × 150p) ÷ 5 = 950p ÷ 5 = 190p

If you take up your rights, your average cost moves to the blended 190p. If you do nothing, the market often gravitates toward TERP when the shares go ex-rights, and your percentage ownership falls.

Where rights are tradable, the nil-paid right usually has a theoretical value on the ex-rights date equal to TERP minus the subscription price. Using the same example, that is 190p minus 150p, or 40p per right. This is what a buyer would theoretically pay to gain the option to pay 150p for a share that should be worth around 190p once issued. Actual prices can differ with supply, demand and volatility.

Your choices as a shareholder

When a rights issue launches you generally have four options:

• Take up in full. You buy your full entitlement. Your percentage holding is maintained. You need cash to fund the purchase.
• Sell the rights. If rights are renounceable you can sell them in the market, monetising the value without contributing new cash. Your stake will dilute when the new shares are issued.
• Partly take up and partly sell. You can blend the two, for example funding part of your take-up by selling the remainder of your rights.
• Do nothing. Your rights lapse. In some markets, underwriters sell the lapsed portion and you may receive any net proceeds after costs, though there is no guarantee of value.

Your decision usually turns on the company’s prospects, the discount, your portfolio concentration and liquidity, and whether dilution of earnings per share matters to you. More shares outstanding affect per share metrics such as EPS, which feeds through to the P/E ratio.

Dilution and how the market often reacts

A rights issue increases the share count. If profits do not rise by at least the same proportion, per share measures fall. That is dilution. The subscription discount, deal size and backstory influence how the market responds.

• Price adjustment. On the ex-rights date the share price often moves toward TERP, which is a mechanical effect of mixing old and new shares.
• Signal. A modestly discounted raise to fund sensible growth can be viewed positively. A deep discount to repair a strained balance sheet can weigh on sentiment, at least until the risks ease.
• Overhang. Rights trading and subsequent issuance can add short term selling pressure as some investors monetise rights or rebalance after allocation.

Underwriting reduces execution risk for the company, but it does not remove share price risk for investors. If market conditions worsen during the offer period, the clearing price of rights and the post-issue share price can be volatile.

Variations and market practice

Rights issues come in several flavours:

• Renounceable vs non-renounceable. Renounceable rights can be traded, giving holders flexibility. Non-renounceable rights must be either taken up or allowed to lapse.
• Fully vs partially underwritten. A fully underwritten deal guarantees the company the full proceeds. Partial underwriting covers only a portion.
• Accelerated or two-stage structures. Some markets use short timetables or institutional tranches followed by retail offers.

Terminology varies too. You may see phrases like entitlement, nil-paid rights, rump placing and excess application facility. Rights may trade with a separate ticker and settle like any other listed security during the offer window. Broker processes also differ, so the exact steps and cut-off times depend on your provider.

Tax treatment and documentation differ by jurisdiction. Local rules on pre-emption, disclosure and shareholder approval are not the same everywhere and can change. If you are unsure how a rights issue affects you, consider getting professional guidance that reflects your circumstances.