Rights Issue: Definition, Procedure & Factors

Instructor: Michelle Reichartz

Michelle has lead multiple training initiatives and has a master's degree in Business Administration.

In this lesson, you will learn what a rights issue is, how the process of issuance is completed, and what possible factors can play a role throughout.

Creme-Filled Dreams

You are the CEO of a very successful cupcake bakery chain. Although business has been good and the company's stock has reached new highs, you are looking to expand your market and continue growth. With this thought in mind, you start working on the idea of going into the creme-filled cupcake business.

Your next great business idea

As great as the creme-filled cupcakes sound, the company doesn't currently have the money available to invest in additional time and resources. Most of your available assets have gone into opening new bakery stores.

In order to fill the cupcakes, your business will need additional waiting time to let the cupcakes cool along with the pastry bags and tips needed to properly fill the cakes. Where will you get the money needed to buy your new resources and continue your thriving business?

What is a Rights Issue?

This is where rights issue comes into the picture. Rights issue is when a company offers its current shareholders the option to buy the right to purchase new shares at a rate below the current market price. In short, the shareholders buy the rights to new stock.

Example of a Stock Certificate. A stock certificate is the paper representation of the number of shares owned in a company.

Why would a company offer new stock at a discounted rate? Companies typically decide to offer rights issues when they are low on cash and require additional funds. The additional funds can be used for anything from paying off debts to investing in new equipment or resources. If a company desires to acquire another company, the funds could serve as the additional amount needed to make the deal go through. Offering a rights issue does not necessarily mean that company is in serious trouble.

Back to the Bakery

After talking over your new creme-filled idea with senior management, you decide to go forward with issuing a rights issue to raise the funds needed. The additional money will go toward buying the new equipment and space needed for this new product.

Your Proposed Cupcake Look and Filling

The company currently has 500 shares of stock issued at a value of $10 a share. To raise the funds needed, the bakery plans to issue 500 shares to its current shareholders at a rate of $5 a share. This means that for every share of stock the current holders own, they can buy 1 share of the new stock. This offering will raise an additional $2,500 for the company, providing the money needed to fund your creme-filled cupcakes.

Once the shareholders receive the rights issue offering, they have three choices:

1. Purchase the rights to the new stock

2. Ignore the offering for the new stock

3. Sell their rights to the new stock to someone else

The Impact of New Stock

Due to the rights issue creating new stock, the price of your current stock will also change in response. Once you determine the number of shares to issue and the rate at which you will offer them, you will want to evaluate what the new value will be.

In our bakery example, the new stock value would be calculated as follows:

The current value of 500 shares of stock at $10 a share would equal $5,000.

We previously determined that the rights issue will offer 500 new shares at a rate of $5 a share, equaling a total of $2,500.

This will mean that the bakery has a total of 1,000 shares at a total value of $7,500.

The new value per share would now be the total value ($7,500) divided by the total shares (1,000) for an updated value of $7.50 a share. The value of your stock will go down based on the number of new shares and the rate per share that is being given.

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