Definition: Right Shares or Right Issue implies an invitation to the company’s existing shareholders to buy additional new shares through a Letter of Offer. These shares are introduced, at a discounted price, i.e. the price at which the company’s existing shareholders will buy the shares is lower in comparison to the market price of the shares.
In general, the company brings a right issue, when it does not want to raise funds by way of loan or issuing debentures. Besides this, it is one of the economic ways of raising finance.
- The existing shareholders get the pre-emptive right to subscribe for additional shares. This right is either by Charter or by Act that applies. With the effect of this right, the equity shareholders are given the first option to buy additional shares, offered as a right issue.
- No prospectus is issued when a right issue is made, rather a Letter of Offer and Application Form is given to the existing shareholders.
- The issue is made in the proportion to the shares held by the present shareholder.
- The price offered to the existing shareholders is generally lower than the listed price.
- A special resolution needs to be passed by the shareholders at the meeting, to authorize such an offer.
Why the price of the right shares is lower than the listed price?
The price of the right shares is fixed at a discount so that the existing shareholders can be encouraged to subscribe to additional shares.
Now there can be the following possibilities:
- The shareholder can exercise the right.
- The shareholder can also renounce their right in favor of some other person
What is the Record Date?
The date on which the company announces the right issue is called the Record Date. Plus, you need to be a shareholder of the company on that particular date, so as to be eligible to apply for the right issue. It must be noted that to apply for the shares, the company gives a window – a beginning date and end date, and between these two dates the shareholder needs to apply so that he can get the right shares. This window is usually open for 30 days.
Purpose of Right Issue
- Controlling Power: It tends to keep the power of control of the existing shareholders. Think of a situation when there is no such right, then the present shareholders may have to compromise with their controlling power when shares in large numbers are offered to the general public.
- Prevention of Loss: It also prevents loss to the present shareholders owing to the dilution of the value of the shareholdings.
Valuation of Rights
The right issue is made at a price that is less than the market price. This is done because – the company wants to give some benefit to the existing equity holders on account of their continued relationship with the company. Plus, the company also wants it to be successful. Hence, the company considers the possible fall in the market value of the shares because of the right issue.
As the right issue is made at a concessional price, the present shareholder can make a profit by selling the right in favor of other people, to apply for shares. The share price may either be cum-right price or ex-right price.
What is Cum-Right Price?
Cum-Right Price gives the buyer the right not just to give the ownership of the shares which are already held, but also the right to apply for extra shares which the company offers.
What is Ex-Right Price?
Ex-Right Price gives only the owner of the existing shares which the seller holds and not the right to apply for extra shares which the company offers. One can determine the ex-right value of a share by subtracting the value of right from cum right market price.
Cum-Right Price is usually more than the Ex-right price because the value of the right is included in cum-right price.
Calculation of Value of Right
Market Price is denoted by M
Number of Existing Shares denoted by N1
Number of Right Shares denoted by N2
Issue Price is denoted by I
Mega Company Limited advances its capital by issuing 2 shares at ₹ 32 each for every 10 shares held. The market price of the existing shares is ₹ 40 cum right. Come let us calculate the Value of Right.
Existing number of shares (N1) = 10,
Market Price (M) = 40
New Shares issued (N2) = 2
Issue Price (I) = 32
A word from Business Jargons
When a company requires funds to undertake existing operations, it issues the right shares. Share prices of the company may fall as the same amount of profit will be distributed, to more number of shareholders