Rights Issue

A rights issue is that relatively rare occasion in a company's life when it will create new shares, the proceeds of which will go directly into its bank account, instead of giving a profit (or a loss) to an existing shareholder.

Successful rights issues require the same sort of judgment about what to charge for a share as is required for a new issue, except that in the case of a rights issue the company will already have a track record with investors and the stockmarket will have established a value for shares in the market.

If you already hold shares in a company making a rights issue, you are effectively being invited to buy more shares at a discount to the prevailing price in the stockmarket.

The number of shares you will be offered will depend on the number of shares you already hold and the terms of the offer. For example, if you hold 2000 shares in Widget Corporation of London and an offer is being made on a one for two basis, you will be invited to buy up to 1000 new shares.

To give you an incentive to take part, the shares are almost certainly going to be issued at a deep discount to the current market value - a 20 per cent reduction is common. As a result, the market value of existing shares is likely to fall after a rights issue.

Essentially, with a rights issue, shareholders are being given first refusal to buy shares as compensation for the fact that the value of their existing shares is going to go down.

Around the time of a rights issue, the company's shares are described as 'cum-rights' or 'ex-rights'. Cum-rights means that anyone who buys shares in the company will be entitled to subscribe for the new shares; but on and after the date of the new issue, shares become ex-rights, and the right to subscribe to the new shares stays with the seller.

Like options and warrants, rights can be traded on the stock exchange. Their value will be roughly equivalent to the ex-rights market price minus the price of the new issue.

Last Updated: May 2007 © Moneyextra.com

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