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Investing in stocks often involves more than just buying and selling shares in the open market. Companies may occasionally offer existing shareholders unique opportunities called rights entitlements.
By exercising your rights entitlement, you can increase your stake in the company while benefiting from the reduced share price. However, it is also crucial to understand the potential risks associated with rights offerings.
In this article, we will discuss the concept of rights entitlements, their benefits and their risks. Stay tuned!
What is the rights entitlement?
Rights issues are a way for publicly traded companies to raise additional capital from their current shareholders.
An existing shareholder’s right to purchase more shares at a price proportional to their current ownership is a rights issue. There is typically a reduction in market pricing for rights issues. This reduced rate is known as the subscription price. Additionally, allocations are guaranteed because they are exclusively available to current shareholders.
A rights issue is a public announcement of the total number of additional shares eligible shareholders can purchase. Rights entitlement now refers to the same thing; the only difference is that the qualifying shareholders’ demat accounts receive a credit.
All eligible shareholders will get the RE units deposited into their demat accounts automatically if they are shareholders of the organisation on the record date stated in the rights issue scheme.
Aside from the record date, business also notifies the distribution ratio of the REs to the shareholders.
There are two main categories of rights issues. There is the option of fully paid-up shares, where you, as the shareholder, make one payment. So, you won’t be required to pay the business recurrently. Plus, the business can’t charge you again for the right issue of shares.
Another kind is partially paid-up shares. This is where the complete payment can be requested by the business. Put simply, the company can demand instalments of the rights issue amount for partially paid-up shares.
Example
Let us understand the concept with an example.
Suppose a company declares that the shareholder is entitled to 1 RE for every 20 shares at ₹100. The market price of the share is ₹150. Now, let’s say, your demat account has 400 shares, so you will get: 20 REs (400/20).
This means you are eligible to apply for 20 shares at a price of ₹100 each, where the market price is ₹150, using your rights entitlement. You should expect the rights entitlement to be deposited in your demat account prior to the issue opening date.
Benefits of rights entitlement
A crucial perk of rights entitlement is that it allows current shareholders to invest additional funds in a business at a lower price. Those who think the company has growth potential and would like to raise their stake in it can consider this an excellent alternative.
Companies can also generate funds through rights entitlements. Businesses can avoid the hassle of issuing new shares to the public by giving current shareholders the option to buy more shares at a reduced price. This approach helps them raise capital.
Risks and impacts on the share market
A business’s stock price can be affected by the issuance of rights, which reduces the value of current shares.
Picture an organisation that has 10 million shares in circulation. The aggregate number of claims will reach 12 million if the business issues a further 2 million shares under rights entitlement. Because of this, when the overall number of shares increases, the ownership proportion for each shareholder will drop.
A drop in stock price may result from this dilution. Although the initial dilution is a concern, the stock price might eventually rise and compensate for it if the business uses the funds efficiently to fuel development.
The stock price is a vital factor for shareholders to consider when determining whether they should trade or exercise their rights. It’s wise to consider the pros and cons of increasing ownership against dilution and a lower stock price before making a decision.
Risks involved:
Investing in rights entitlement may be both a lucrative and risky undertaking. The probability that the stock price of the business may fall below the subscription price before the exercise date is a substantial risk.
It may not be in your best interest to use your right to buy more shares at a price greater than their current market value under certain circumstances.
The possibility of dilution is yet another risk that you need to consider. The current shareholders’ stake in the business might be reduced if new shares are issued through a rights entitlement. As a result, the value of their current shares may decline.
Finally, think about how taxes and fees will affect your investment. There may be costs levied by the brokerage or the organisation when you exercise your RE. In addition, capital gains taxes might apply to the earnings you make when you sell your rights entitlement or additional shares.
Conclusion
Rights entitlement offers existing shareholders a unique advantage – the opportunity to increase their stake in a company at a discounted price before new shares are issued to the public. However, it’s crucial to approach this decision with careful consideration.
By weighing the risks and benefits, you can make an informed choice that aligns with your objectives and risk appetite.
FAQs
Eligibility for a rights issue in India is determined by the record date set by the issuing company. Shareholders who own shares before the ex-date, which is usually one day prior to the record date, are eligible to participate. Purchasing shares on or after the ex-date disqualifies an investor from the rights issue, as the ownership is not reflected in the company’s records on the record date.
Trading Rights Entitlements (REs) in India involves shareholders selling their REs through a broker on the stock exchange. The transactions are settled through the depository system, similar to other securities. Trading begins with the opening of the rights issue and typically ends a few days before the issue’s closing date, allowing shareholders to liquidate their entitlements if they choose not to subscribe.
Selling shares after a rights issue in India is straightforward for shares of listed companies, as they can be traded immediately once credited to the shareholder’s demat account. For unlisted companies, however, shareholders may need to wait for the company to provide an exit option or until the shares are listed on an exchange, which could delay the ability to sell the new shares.
Benefits of a rights issue for companies in India include the ability to raise capital quickly from existing shareholders, which can be crucial for expansion or paying off debts. It also saves on costs associated with public offerings, such as advertising and underwriting fees. Moreover, a rights issue can improve a company’s debt-to-equity ratio, enhancing its financial health without increasing its debt burden.
If a rights issue in India is not fully subscribed, the unsubscribed shares can be allotted at the discretion of the company’s Board of Directors. They may choose to distribute the remaining shares among existing shareholders, including promoters, or offer them to other investors. This process is typically outlined in the terms of the letter of offer sent to shareholders. The Board’s decision aims to ensure that the company still raises the necessary capital.