The companies for general corporate purposes such as expansion, acquisition may well be in need of funds and for this purpose many a times they raise capital by issuing or offering shares to their current shareholders in the proportion of their existing shareholding at a discount in comparison to market price. This is what is referred as rights issue but investors or existing shareholders need to factor in these parameters before subscribing to the rights offer or issue.
1. Discount offering in a rights issue: It is the main factor that an investor can consider if he or she wishes to subscribe to the issue. Say if you are an investor in 1000 shares of ABC priced at Rs. 6 and the company wants to expand into different business vertical and for this it comes up with a rights offer of 10 million shares and plans to raise Rs 3 crore then it is a 3 for 10 rights issue which means for every 10 shares you have there is an offer to buy another 3 shares now at a discounted price of Rs. 5.5.
2. Investors should understand rationale or objective of Rights Issue: As with the IPO, investors should clearly know the purpose of the company's rights issue and the reasons for it can range from debt repayment, acquisition, diversification etc.
3. Dilution of company share value coming up with the Rights Issue: Undoubtedly the rights of each of the existing shareholder are preserved as the issuance or offer is strictly in proportion to their current equity shareholding. Also, the same proportion of voting rights is maintained.
With the issue of new shares via rights issue, value of existing shares of the company in the market is diluted as the outstanding number of shares goes up. Though, valuation shouldn't be the concern as shares are issued only to the existing shareholders of the company. Nonetheless, shareholders also have the option to sell their rights.
For the company, the rights issue is resorted to in a situation when the lending institutions are reluctant to lend and it is a relatively cheaper way of raising funds as the company can save on interest cost. Also, the time and cost associated with the floatation of the rights issue can be saved. The rights issue offer also signals that the company promotes long term ownership by shareholders in its equity.
On the other hand, the stock market could view the rights issue offer by the company as a cash crisis within the firm as well as a lack of demand for company's equity in the open market.