In this article we will discuss about:- 1. Reasons for a Rights Issue 2. Advantages of Rights Issue.
If an existing company intends to raise additional funds, it can do so by borrowing or by issuing new shares. One of the most common methods for a public company to use is to offer existing shareholders the opportunity to subscribe further shares. This mode of rising finance is called ‘rights issues’.
The existing shareholders have right to entitlement of further shares in proportion to their existing shareholding. A shareholder who does not want to buy the right shares, his right of entitlement can be sold to someone else.
The price of rights shares will be generally fixed above the nominal value but below the market price of the shares. The issue of quoted shares at below the nominal value is not allowed, and it would be rare for this to happen for unquoted shares.
Section 81 of the Companies Act provides for the further issue of shares to be first offered to the existing members of the company, such shares are known as ‘right shares’ and the right of the members to be so offered is called the ‘right of pre-emption’. Section 81 of the Companies Act, 1956 deals with the provisions relating to rights issues.
Reasons for a Rights Issue:
The main reasons to make a Rights issue by a company are as follows:
(a) In times of inflation, the replacement costs of assets will be high, unless the company can retain cash from substantial profits, the only alternative is to raise cash from a fresh issue of shares.
(b) For funding expansion projects, a company may make rights issue.
(c) If a company has a proportion of interest bearing loan capital, the company can suffer from a squeeze on profits. The company can improve the capital structure position by obtaining extra share capital.
(d) At a time when the share prices were relatively high, companies found it easy to persuade their shareholders to subscribe cash for new issues with a view to expansion by takeover.
Advantages of Rights Issue:
i. To Companies:
The company benefits from lower issue costs, in that administration and underwriting costs are lower and the issue is made at the direction of the directors rather than via a general meeting of the company. This is because issues of equity through the stock exchange will alter the balance of ownership.
ii. To the Shareholders:
The main attraction of the rights issue for current shareholders is that they are able to maintain their original proportion of share ownership. Furthermore, any transfer of wealth away from them due to an equity issue being under priced, is avoided.