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Rights issue (If an existing shareholder receives a notification of a…
Rights issue
If an existing shareholder receives a notification of a rights issue from a company there will be five possible courses of action
- To take up all of the rights as allocated in the rights issue. This would maintain the shareholder's percentage holding and also maintain their same degree of control although this is via an increased number of shares. Additional capital will have to contributed. Although the value of each individual share will in theory fall, the size of the shareholding will increase, as will the value of the portfolio in cash terms. The investors bank balance will fall by the amount paid for the rights
- To take up a proportion of the rights while selling the remainder. An investor's percentage control of the company will diminish. Additional cash will still have to be contributed. The total number of shares held will increase and the cash value of the shareholding will increase, however the percentage control of the company still decreases. Although the investors bank balance will reduce, cash will still be received by selling some of the rights
- To sell all of the rights. This will dilute the shareholder's percentage holding but they will not have to contribute any additional capital and will receive money for the sale of these rights. This will increase their bank balance although the value of the share portfolio will decrease
- To do nothing. The company will sell the rights on the shareholders' behalf and send the proceeds to them. The value of the shareholder's portfolio will fall as will their percentage holding, but their bank balance will increase
- To sell sufficient rights and use the resulting capital received to exercise some rights to purchase a percentage of the shares. In this case, there is no capital contribution. The cash value of the shareholder's portfolio will remain unchanged although there will be an increase in the number of shares held but with reduced control as no additional capital was provided. There may be some impact on bank balance. This is often referred to as 'tail swallowing'
The existing shareholders may purchase some additional rights in the secondary market and above their allocation in order to increase their percentage holding even further; this will reduce their bank balance
Cum rights and ex rights
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Cum rights
Securities are traded on the stock exchange before the ex-rights cut off day. This means that if an investor purchases shares cum rights, they will receive shares together with the rights to buy new shares. The price that the investor will pay will be the market price, which factors in the value of those rights
Ex rights
An investor purchasing shares will buy without receiving the right to participate in the rights issue. This price will obviously be lower and will be the price less the value of the rights. This price is referred to as the ex-rights price of a share. It is similar to the theoretical market price subsequent to a rights issue
A way in which a company can raise additional capital by selling new shares, usually for a specific purpose such as business expansion, but may also be used a means to reduce reliance on existing debt capital particularly if interest rates are high
A method by which a company can obtain additional capital by selling new shares. Rights issues give the right to existing shareholders to subscribe for new shares in a company in direct proportion to their existing holdings. Allocations are made in the form of a rights letter
The existing shareholders have an absolute statutory right contained within the Companies Act 2006 to subscribe for the new shares in the company prior to those shares being offered to external investors. This is in order that they can prevent their existing percentage shareholding from being diluted, while at the same time maintaining their existing level of control. This right is referred to as the right of pre emption
These rights will not only have the effect of increasing the assets of the company, as they must be paid for in cash, but they will also reduce the value of each existing ordinary share and the percentage control of existing shareholdings
If an investor does not take up the rights, the size of the share portfolio will remain the same the overall cash value of the portfolio should remain constant. If the value of the rights is included it shouldn't remain constant as it will be comprised of the existing shares and the rights which will have a value
Alternative to bank borrowing or increasing debt capital by other means and is relatively inexpensive form the company's perspective as new capital is raised in the form of cash
The current shareholders must be allowed to maintain their existing percentage control of the company should they so wish
The existing ordinary shareholders are only allowed to subscribe for the new shares in direct proportion to their holding, this a right an not an obligation and existing ordinary shareholders are not compelled to contribute any additional capital
Each of the new shares will possess the same rights as the old shares, for example in relation to voting rights and receipt of dividend payments
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The new shares will be offered to the existing shareholders in direct proportion to their existing holding. For instance, they may be offered one new share for every four ‘old’ shares currently held.
In order to encourage the existing shareholders to subscribe for the new shares, they will be given the right to subscribe for them at an often substantial discount to the prevailing market price. This is generally in the region of 15-20% discount on the closing market price on the day before the announcement of the rights issue
The rights to the new shares become fully tradable securities in their own right as they give the holder or the potential holder the right to purchase new shares at a discount to the prevailing market price
In the first instance, the existing shareholders are given rights to subscribe for new shares at a stated price, as the shareholders have paid nothing for these rights, they are referred to as nil paid
A rights issue in order to finance expansion will generally be viewed favourably by both shareholders and the markets
Rights issues are undertaken by issuing houses, which will arrange to have them underwritten, usually by City institutions. These will in turn guarantee to take up any shares for which the existing shareholders have not subscribed. This will be on a pro rata basis and will be agreed by the various underwriters and sub-underwriters at the outset
If shareholders do not exercise any of their rights or sell some or all of their rights, their percentage holding in the company will have reduced because, although they have the same number of shares as before, there are now more shares in circulation. These shares will have a reduced value. Shareholders ought not to lose out as will receive the proceeds of their rights, thus increasing their bank balance, although control of the company will decrease