A rights offering is an opportunity offered to the shareholders of a company to purchase additional shares typically below the market price and at no cost. In essence, this is a cash call made by the issuer to its existing shareholders thus giving them an opportunity to buy additional shares at a particular share price.
What you need to know is that every shareholder has one right for each share they own. This right cannot be translated into an obligation and shareholders of the company can decide to purchase or not to purchase the additional shares. Furthermore, shareholders have the option of selling their rights to another investor.
When it comes to rights offering, there is no dilutive effect which means the company does not have to seek approval from shareholders when they issue 20% or more of the outstanding shares. Before commencing, the company is required to set an open period that ranges between 16 to 30 days. Also, no federal securities laws require the rights offering be open for a particular period.
Types Of Rights Offering
There are a couple different rights offering which include a direct rights offering and insured rights issue.
Direct Rights Offering – Here, the company (issuer) is required to sell a particular number of shares which is stipulated in the exercised rights. This option is known to be cheaper compared to insured rights offering. Why? No fees are charged if the issuer is providing a backstop commitment. Despite this, a poorly subscribed offering will result in the issuer being under-capitalized.
Insured Rights Issue – A third party for example an investment bank or an affiliate is usually issued with the opportunity of purchasing shares which are currently not being governed by the rights offering. Also referred to as a backstop commitment, this opportunity accords the issuer with the chance of raising capital. An agreement between the backstop provider and the issuer must be completed beforehand.
Benefits Of Rights Offering
- A rights offering is one of the easiest ways issuers can use to raise funds. There are several reasons why a company needs finance. They include paying off debts, purchasing equipment or acquiring another company.
- Less marketing efforts is required since the issuer is making the offering to existing shareholders and not the public.
- A rights offering announcement has been found to act as a market interest trigger which renews investors interest in purchasing shares from the issuer.
- The issuer is supposed to offer the shares at a discount which means shareholders will not incur additional costs. As a result, the shares will be available below market price.
- As an alternative form of raising capital, it is quite advantageous during economic slowdowns when lenders are reluctant to lend funds.
- SEC filings and other procedures must be completed before a rights offering is conducted. This eliminates some of the financial benefits that the issuer enjoys.
- Sale of additional shares may result in concentrated investor positions. If sold to outsiders, it may place excessive control in the hands of outsiders.
Every company can be faced with financial problems and one way to save itself is through additional financing. Borrowing from a lender can take time resulting in the liquidation of the company. By issuing additional shares to its shareholders, the issuer will attract additional funding which can be used to fund company projects.