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Pankaj Tyagi
| Updated: 30 Apr, 2021 | Category: Compliances

Potential Benefits and Downsides of Right Issue of Shares

Potential Benefits and Downsides of Right Issue of Shares

The right issue of shares is a method to procure funding of the companies listed on the stock exchange. When a company goes through a bad economic patch, it intimates the existing shareholders for additional funding for an issue of shares at discounted prices. Therefore, such a case is regarded as the right issue.

An organization provides shares at a discounted price lower than its market value during the right issue process. Right issues of shares come in handy when it comes to overcoming the financially stressed situation of the company. In this write-up, we will focus on certain advantages and downsides of the right issue.

What is meaning of Right Issue of Shares?

A right issue is referred to as an offer to shareholders to acquire additional shares of the organization at a discounted price. The right issue is done in accordance with the existing holdings & is needed to be subscribed within a particular period. The right will lapse if the company fails to comply with the said timeline.

  • The rights issue refers to a primary market issue. 
  • The offer is accessible to the existing shareholders & not to the public in general.
  • It is the shareholder’s right and not accountability to purchase the additional shares.
  • The rights can be sold or transferred if the existing shareholder is not willing to choose the offer.

Read our article:Right Issue of Shares: Step by Step Procedure

Understanding the Concept of Right Issue under Companies Act, 2013

  • ‘Rights Issue’ implies offering shares to shareholders of the company in proportion to their existing shareholding. The idea is to procure the additional funds. 
  • Right issue is practiced by the small firms where the shareholding’s power retains with the company’s shareholders.
  • It is also known as pre-emptive right” that shareholder has in the organization inpreference to an outsider.
  • Any organization can opt for the right issue irrespective of its business structure. 
  • The right issue allows the shareholders to purchase the new shares at a reduced price as that of the market price. 

What are the Key Features of a Right Issue of Shares?

These are some inevitable attributes of the right issue of shares: 

  • It allows the shareholders to trade with interested buyers until a specified date on which new shares are available for purchase. The right issue of trade is more or less identical to equity shares trade. 
  • An organization during the right issue of shares renders some preferential freedom to its shareholders. Thereby the shareholders access the right to buy additional shares at a nominal price prior specified date. 
  • In the right issue of shares, the number of shares buyout by existing shareholders is always in accordance with the existing shareholding. 
  • Furthermore, the existing shareholders also get the right to dismiss the right issue. Also, if shareholders disregard the option of buying additional shares, the existing shareholding would get diluted after the release of the additional shares.
  • An organization can start the right issues only in a demanding situation without incurring underwriting fees.

What are the Considerable Advantages of Right Issue of Shares?

The right issue creates a winning proposition for both the organization and its shareholders. As the organization gets their hands to require funding and the shareholders possess the right to purchase at discounted prices corresponding to existing holding in the company. Have a look at the bright sides of using the right issue in comparison to the other modes of Fundraising:-

What are the Considerable Advantages of Right Issue of Shares

A Swift Way to Raise Capital

Unlike public offerings, the right issue entails less complicated rules as it is more of internal affairs. The only protocol that prevails is that the listed organizations file a letter of offer with SEBI & stock exchanges for public feedback to get approval before issuing new shares.

Rise of Promoter Shareholding

Another significant advantage is that the right issue lets promoters raise their shareholding. The shareholders are eligible to subscribe to an unsubscribed portion’ of the issue, increasing the shareholding.

There is no denying that a right issue is arguably the most secure method for Fundraising. It offers an opportunity for the company to expand its portfolio without any simultaneous increase in debt. With the right issue, an organization can procure additional funding from its existing shareholders by altering the terms of member’s holding. Therefore, it mitigates the scope of the debt. 

Record date refers to a date on which shareholders can purchase the additional shares. The company finalizes this date by taking the shareholder’s permission into account.

Few Drawbacks

Although the right issue is arguably the best source to procure the additional funding, yet oftentimes the companies have to confront some downsides of it. Here are the most general downsides of the right issue. 

The Size of Fundraising is Limited

The obvious downside is that an organization cannot procure an amount in case of an IPO. The stock exchanges do not allow the company to raise funds via the right issue to the full potential. Also, such a limitation is proportional to the company existing equity value.

The right issue is generally achieved by undervaluing the stocks so that shareholders can purchase them with ease. This might be a good option in case of sudden financial need, but it might create pressure on the company in the long-term.

Value of Share Eroded

At the time of equity share, the stake dilution of existing shareholders is very much on the card. As the percentage shareholding gets minimized on the advent of new shareholders[1], it can push the existing shareholders towards a stressful situation. 

Conclusion

Despite having several pros and downsides, one must admit that the right issue is the most secure method for procuring additional funds. However, such a fundraising method is subjected to certain rules and regulations that the company must follow. Share your concern with us in case you have any doubt regarding this topic i.e. pros and downsides of right issue. 

Read our article:Issue of shares on Preferential Basis: A Complete Procedure

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Pankaj Tyagi

Pankaj has a diverse experience of writing research papers, blog, and articles during his college time. Earlier, he was working as a tax consultant in a financial firm, but his interest in writing drives him to pursue a career in the writing field.

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