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Attracting new investors and raising additional capital is crucial for a company’s growth strategy. When a company issues new shares to raise capital, it sometimes offers a unique opportunity to existing shareholders through a mechanism known as nil-paid shares.
These shares are essentially a type of rights issue, where current investors may purchase additional shares at a discounted price. However, what sets nil-paid shares apart is that the company hasn’t received any payment for the nominal value or premium during the initial issuance.
That said, let’s take a closer look at nil-paid rights and how they work.
Understanding nil-paid rights issue
The phrase “nil-paid” implies that the shares were not paid for by the investors. This is common when a company offers shares via a rights issue. This allows shareholders to buy more shares at a discounted price. The shareholder remains liable for any dividends that may be due on the shares in the future.
A right is an option granted to shareholders by a business to buy more shares, often at a discount. The shareholders get these rights for free, and if they can renounce them, they may sell them if they want to.
Nil-paid describes tradeable rights, initially granted to a security’s owner at no cost to them. The term renounceable rights describes a kind of transferable right. The rights become known as nil-paid rights when they are traded.
How nil-paid rights work?
When you hear the word nil-paid you may think that nil-paid rights provide investors with no-cost access to new shares. This isn’t entirely true, though. They only represent the option to buy more shares at the current price or a discount.
There is no monetary exchange between the company that issues shares and the shareholders. The securities will need to be paid for by shareholders if they exercise their rights.
Most rights are tradeable. The term for this is renounceable rights. Contrarily, there are distinct rights that are non-renounceable. When shareholders cannot renounce their rights to another entity, those are non-renounceable.
Present shareholders get an invitation to purchase more shares of the company at a predetermined price. Usually, the price range is lower than what the market is currently selling for. To avoid diluting the holdings of current shareholders, businesses often employ non-renounceable rights to acquire capital.
Nil-paid rights calculation
To determine the profit from selling the rights to shares held in a position, you must first assess the value of the non-paid rights. Finding a precise number is challenging. But if you take the ex-rights price and deduct the rights issue price, you could have an approximate estimate.
For example, a corporation may issue a new share for ₹20 for every five existing shares. Take the current share price of ₹35 as an example. So, when the new share is issued, you may expect the company shares to trade for around ₹32. Because of this, the total comes to ₹160 (5 x 32 rupees). Now, (160 + 20)/6 = ₹30 is the ex-rights price.
A shareholder may transfer his rights if he chooses not to use them. Nil-paid describes the price after subtracting the expected ex-rights price from the issue price. Here, Rs. 20 minus Rs. 10 equals Rs. 10. It is possible that an investor who was uninvited to the first rights auction may be interested in purchasing nil-paid rights.
Why do businesses offer nil-paid rights?
Companies often seek additional capital by issuing nil-paid rights to meet their current financial obligations. Companies in a financial crunch require additional capital. However, new funding can take a while to come through. These companies issue nil-paid rights.
But even financially stable businesses might provide nil-paid rights. Reputable companies may enhance their company’s development with additional funding. It might include building additional manufacturing facilities, launching retail stores, or acquiring other companies.
Instead of paying off debt, growth is the goal of this nil-paid rights sale. So, the possible future gains might be greater than the risk that comes from reducing the number of shares that are still out there.
Conclusion
The concept of nil-paid shares is a strategic tool companies employ to attract new shareholders and raise capital. This approach not only broadens the company’s shareholder base but also provides shareholders with the flexibility to make informed decisions based on their investment goals and financial circumstances.
FAQs
Nil-paid rights are the rights that shareholders receive to buy additional shares at a discounted price during a rights issue. To trade nil-paid rights, you would typically do so through a stock exchange using a registered broker. If you decide to exercise these rights, you must pay the subscription price to convert them into shares. If you choose not to exercise them, you can sell them in the open market before they expire.
In India, you cannot directly sell shares without first owning them. The process of buying and selling shares is facilitated through stock exchanges and requires a registered broker to execute the transactions on your behalf. If you wish to sell shares, you must have them in your Demat account. Short selling, where you sell shares you do not own, is possible on an intraday basis, but you must square off your position by the end of the trading day.
A rights issue can be good for shareholders as it offers them the opportunity to purchase additional shares at a discounted price, potentially increasing their stake in the company at a lower cost. However, it’s not just about the discounted price; shareholders should also consider the company’s valuations, performance, and the objectives behind the rights issue. A rights issue can be beneficial if it’s used for growth or debt reduction but could be a sign of financial distress.
The primary disadvantage of a rights issue for shareholders is the potential dilution of their holdings. If shareholders do not exercise their rights to buy additional shares, their percentage ownership in the company decreases as new shares are issued. This dilution can lead to a reduction in the value of each share and may also impact the control shareholders have over the company. Additionally, a rights issue might indicate that the company is cash-strapped and unable to raise funds through other means.
Nil-paid shares in India are considered liquid because they can be traded in the open market. However, they are not as liquid as fully paid shares. The liquidity of nil-paid shares depends on the demand from other investors who may be interested in acquiring the rights to buy additional shares at a discount. The trading window for nil-paid shares is usually limited to the period before the rights issue closes, which can affect their liquidity.
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