Inching closer to the cashier at your favorite coffee shop, your thoughts turn to an upcoming right issue. You’re leaning toward participating in the issue but is rights issue good for shareholders? Keep reading to make an informed decision.
Is Rights Issue Good for Shareholders?
A rights issue can be good or bad for shareholders depending on certain conditions. Let’s look at the advantages of rights issues to address, is rights issue good for shareholders?
Buying Below Market – A rights issue is an offer to existing shareholders to purchase additional shares prior to the shares trading in the open market. A company extends this opportunity at a discount relative to the firm’s current share price. The shareholder advantage is acquiring additional stock cheaply from a known company with the possibility of future appreciation.
Dilution Avoidance – Current shareholders have the first right of refusal to acquire the rights issue shares. If a shareholder elects to participate in the offer, she will maintain her current proportional ownership and will avoid dilution.
Long-Term Growth Potential – A company’s motivation for extending a rights issue can be an advantage to shareholders. A rights issue raises additional capital for the offering firm. If the additional capital is allocated for growth pursuits, dividends, share buybacks, or voluntary debt reduction, shareholders will benefit from the value created.
Confidence Signal – Pursued as a precursor for growth initiatives, a rights issue can be a signal of the company’s confidence about its future prospects and can positively impact its short-and medium-term share price.
Is rights issue good for shareholder? Yes, rights issues can be good for shareholders given the right circumstances. However, there are various factors that can negatively impact shareholder goodwill.
What are the Disadvantages of Rights Issue to Shareholders?
The disadvantages of rights issue to shareholders are:
Short-Term Dilution – Non participation in a rights issue has a price. If a shareholder decides not to invest in the rights issue shares, his current fractional ownership in the company will be reduced.
Share Price Impacted – An announced rights issue can cause the company’s shares price to fall because of potential value dilution, an increase in outstanding shares, or an unclear or poorly communicated motive behind this corporate action.
Additional Funds Requirement – A rights issue is only an opportunity if a shareholder has the additional funds to participate. If funds are not available, the investor will lose the opportunity and experience dilution.
Distress Signal – At times, a rights issue is viewed as a sign of financial distress. The market may perceive the firm is in fiscal trouble and needs additional capital to stave off bankruptcy, cover mounting losses, or pay off overdue debt. Negative market perceptions adversely impact stock prices bleeding into declining shareholder value.
Is rights issue good for shareholders? Yes, it can be but not always. Short-term dilution is possible when electing not to participate in the rights issue, as well as experiencing an initial decline in existing holdings value due to uncertainties going forward.
Is It Worth Applying for Rights Issue?
It may be worth applying for rights issue providing the following factors are considered:
- Company Purpose – Determine why the firm is offering the rights issue. If the reasons are accretive, the issue may be beneficial.
- Your Financial Position – Do you have the additional funds to participate in the rights issue? Obtaining additional shares of a familiar company at a discount is an opportunity that can only be exploited with additional discretionary funds.
- Market Sentiment and Condition – The company’s present performance within the current market conditions should be assessed. Does the market view the firm positively and what type of market conditions will you be investing additional dollars into in the rights issue?
Read next: Right Issue of Shares Calculation: A How-to-Manual
