A rights issue is a mechanism that allows existing shareholders to purchase additional shares of a company at a discounted price before the company offers the shares to the general public. This opportunity is often presented to raise capital for the company to fund expansion, reduce debt, or meet other financial needs. For shareholders, a rights issue offers several potential benefits, but it also comes with risks. It is important to understand the provisions and regulations that govern rights issues under Indian law, as it is inevitable for investors to make informed decisions.

In this article, CA Manish Mishra explores the concept of a rights issue, how it works, and how shareholders can benefit from it, focusing on the relevant provisions in Indian law.

What is a Rights Issue?

A rights issue is a corporate action in which a company offers new shares to its existing shareholders in proportion to their existing holdings. These shares are usually offered at a price lower than the market value, making it an attractive option for shareholders to increase their stake in the company. Importantly, the right to purchase additional shares is offered to the existing shareholders, and it is not mandatory. Shareholders have the option to accept the offer, decline, or renounce their rights.

The shares issued through a rights issue are typically offered at a discount to the current market price, making it an appealing way for shareholders to acquire more stock at a lower cost.

How Does a Rights Issue Work?

A rights issue is typically structured as a pro-rata offering, meaning shareholders are given the right to buy a specific number of shares for every share they already own. For example, in a 1:1 rights issue, a shareholder who owns 100 shares would have the right to purchase an additional 100 shares at a discounted price.

The company will announce the rights issue with the following details:

• Issue Price: The discounted price at which the shares will be offered.
• Record Date: The date on which the company's shareholders must be on the company's books to be eligible for the rights issue.
• Offer Period: The time frame during which shareholders can exercise their rights to purchase additional shares.
• Ratio: The proportion of new shares offered relative to the existing shares held by the shareholder.

Once the rights issue is announced, existing shareholders receive rights letters or notices indicating their entitlement. They can then choose to accept the offer, reject it, or trade the rights on the stock exchange.

Benefits to Shareholders from a Rights Issue

• Opportunity to Purchase Shares at a Discount: One of the primary benefits of a rights issue is the ability for shareholders to buy additional shares at a discounted price. This gives shareholders the chance to increase their holdings in the company at a price lower than the prevailing market price. For example, if the company’s stock is trading at ₹1000, the rights issue might be offered at ₹800, making it an attractive offer for shareholders.

• Preservation of Ownership: A rights issue allows shareholders to maintain their proportional ownership in the company. If shareholders choose to exercise their rights, they can buy enough shares to keep their percentage of ownership in the company unchanged. This is particularly beneficial if the company is planning to issue a large number of shares, which could dilute existing shareholders’ stakes.

• Increase in Value of Shares: If the company successfully raises capital through the rights issue and uses the funds effectively for business expansion or debt reduction, the value of the company may increase. This can result in a higher stock price in the future, benefiting shareholders who chose to participate in the rights issue.

• Renunciation of Rights: Shareholders who do not wish to exercise their rights can sell or renounce them in the market. This provides an opportunity to realize some value from the rights without purchasing additional shares. Shareholders can sell the rights to other investors who might be interested in buying more shares in the company.

• Capital Infusion for Growth: Rights issues often occur when a company needs to raise capital for expansion, research and development, acquisitions, or to reduce debt. When the company uses the funds raised in an efficient manner, it can lead to growth and a corresponding increase in the stock price. Shareholders who participate in the rights issue are essentially investing in the future growth of the company.

• Higher Liquidity: With the issuance of more shares, the liquidity of the company’s stock may increase, making it easier for shareholders to buy and sell shares. This is particularly beneficial for shareholders who might want to sell their holdings in the future.

Legal Provisions and Regulatory Framework for Rights Issues in India

In India, rights issues are governed by various provisions under the Companies Act, 2013, the Securities and Exchange Board of India (SEBI) regulations, and the guidelines of the Stock Exchanges. Below are some key provisions and regulations that ensure the rights issue process is transparent and fair:

• Companies Act, 2013:

  • Section 62(1)(a): This section of the Companies Act allows companies to issue shares through a rights issue. It states that a company may issue shares to existing shareholders in proportion to their existing shareholding, subject to approval by a special resolution at a general meeting. The provisions ensure that the shareholders are given an equitable opportunity to purchase new shares and maintain their ownership stake.

• SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR): SEBI regulates rights issues under the ICDR Regulations, which set the guidelines for the process. Some key provisions include:

  • Regulation 6: This regulation mandates that a company offering a rights issue must provide a detailed offer document, disclosing key information such as the rationale for the issue, the use of proceeds, and the offer price.
  • Regulation 9: SEBI requires that the rights issue offer be open for at least 15 days but no more than 30 days, giving shareholders enough time to evaluate and decide whether to accept or decline the offer.
  • Regulation 14: This regulation mandates that the company’s financial statements should be up to date and properly audited before a rights issue can be launched.
  • Regulation 74: SEBI provides guidelines for the allocation of rights issues and the handling of unsubscribed shares.

• Stock Exchange Guidelines: The Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) provide further guidelines on rights issues. The company must ensure that all procedural requirements are followed, including timely filing of announcements and documents with the stock exchanges. These regulations ensure transparency and help protect shareholders’ interests.

• Tax Implications: Rights issues generally have no immediate tax implications for shareholders in India. If the shares are purchased at a discount, the difference between the market price and the issue price is not treated as taxable income. However, once the shares are sold, any capital gain is subject to taxation under Section 10(38) of the Income Tax Act, 1961, if the shares are sold after one year (long-term capital gain), or under Section 111A for short-term capital gains.

GenZCFO Advice

A rights issue offers significant benefits to shareholders, including the opportunity to buy shares at a discounted price, maintain their ownership percentage, and potentially benefit from the company’s future growth. It is a favorable option for both existing shareholders and companies looking to raise capital efficiently. Under Indian law, rights issues are governed by clear provisions under the Companies Act, 2013 and SEBI regulations, ensuring fairness, transparency, and investor protection.

Shareholders can maximize the benefits of a rights issue by carefully evaluating the offer, understanding the use of funds by the company, and deciding whether to exercise, renounce, or trade the rights. While a rights issue offers opportunities for growth, it is essential for investors to be aware of the legal and regulatory framework surrounding such actions to make informed decisions. Contact us if you have any queries or if you want any advisory.

FAQs on Rights Issue Benefits for Shareholders

- What is a Rights Issue?

A rights issue is when a company issues new shares to its existing shareholders at a discounted price, in proportion to their current holdings.

- How Does a Rights Issue Benefit Shareholders?

Shareholders benefit by:

• Buying shares at a lower price compared to the market value
• Increasing their stake in the company without dilution from external investors
• Potential future gains if the share price rises after the rights issue

- Is a Rights Issue Free for Shareholders?

No, shareholders must pay for the additional shares, but they get a preferential price lower than the market rate.

- What Happens if a Shareholder Doesn’t Participate?

If a shareholder chooses not to buy the new shares, their ownership percentage decreases as new shares are issued to others.

- Can Shareholders Sell Their Rights?

Yes, in a renounceable rights issue, shareholders can sell their rights to other investors in the market. However, in a non-renounceable rights issue, they must either subscribe or let the offer lapse.

- Do Rights Issues Affect Share Prices?

Yes, after the rights issue, the stock price usually adjusts downward since new shares are issued at a discount.

- Are Rights Issues a Sign of Financial Trouble?

Not always. While some companies use rights issues for debt reduction or operational losses, others use them for expansion, acquisitions, or new projects.

- How Are Rights Issues Allotted?

Rights issues are typically offered in a ratio format (e.g., 1:3, meaning shareholders can buy 1 new share for every 3 shares held).

- Do Rights Issues Affect Dividends?

Since more shares are issued, dividends per share may decrease unless the company’s earnings grow proportionally.

- Should Shareholders Participate in a Rights Issue?

Shareholders should consider the company’s financial health, growth potential, and investment goals before subscribing to a rights issue.