When my startup needed funds for expansion, we were unsure about taking on more debt. A trusted mentor suggested considering a right issue of equity shares—a way to raise money directly from our existing shareholders by offering them more shares at a special price. It turned out to be a great move, not just for funding but also for keeping our shareholders engaged and invested in our journey. In this guide, I’ll walk you through what a right issue is, how it works, and why it might be a smart choice for your company too.

Let's Understand the Right Issue with a small example:

Suppose ABC Ltd. wants to raise additional capital to fund a new project. The company decides to issue a right issue, offering its existing shareholders the chance to buy additional shares at a discounted price of ₹100 per share, while the current market price is ₹150 per share.

ABC Ltd. announces a 1:5 right issue, meaning for every 5 shares a shareholder owns, they have the right to buy 1 additional share at the discounted price. So, if a shareholder owns 100 shares, they are entitled to buy 20 additional shares at ₹100 each.

This allows ABC Ltd. to raise the needed funds without borrowing, while shareholders benefit by buying shares at a lower price and increasing their stake in the company.

Importance for Companies and Investors

• For Companies: Right issues provide a streamlined way to raise capital for expansion, debt repayment, or other financial needs while preserving control.
• For Investors: Shareholders get the opportunity to purchase shares at a lower price than the market value, protecting their ownership percentage and potentially reaping future benefits.

How Right Issues Work

Right issues involve a structured process designed to ensure compliance and transparency:

Process Overview:

• Announcement: The company announces the right issue, including details like the number of shares, the discount, and the subscription ratio.
• Subscription Period: Shareholders are given a specific timeframe to subscribe to the additional shares.
• Allotment: After the subscription period, shares are allotted to the participating shareholders. Any unsubscribed shares may be handled per the terms of the right issue.

Key Stakeholders:

• Company’s Board: Approves the decision to initiate a right issue.
• Regulatory Bodies: Ensure compliance with legal requirements.
• Shareholders: Evaluate the offer and decide on their participation.

Types of Right Issues

Right issues can be categorized based on whether shareholders can transfer their rights and the payment structure of the shares:

Renounceable vs. Non-renounceable:

• Renounceable Rights: Shareholders have the option to sell their rights to others.
• Non-renounceable Rights: Shareholders must either subscribe or forfeit the offer.

Fully Paid vs. Partly Paid:

• Fully Paid: Shareholders pay the full amount for the shares upfront.
• Partly Paid: Payment can be made in installments.

Benefits of Right Issues for Companies

Right issues offer several strategic advantages:

• Raising Capital Efficiently: Provides the company with immediate funds without the complexities of public offerings.
• Maintaining Control: Existing shareholders are prioritized, minimizing control dilution.
• Strengthening Financial Position: By raising equity rather than debt, companies can improve their debt-to-equity ratio.

Benefits for Shareholders

For shareholders, right issues present a unique investment opportunity:

• Discounted Purchase: Shares are available at a discount, offering immediate value.
• Avoiding Dilution: Participating in the right issue helps shareholders maintain their ownership percentage.
• Potential for Capital Gains: If the company performs well post-issue, the value of the discounted shares can increase significantly.

Impact of Right Issues on Share Prices

Understanding how right issues affect share prices can help companies and investors make informed decisions:

Short-term Impact:

• The announcement of a right issue may initially lead to a drop in the share price due to dilution concerns.

Long-term Impact:

• If the raised funds are used effectively, the company's improved financial health can lead to a recovery and increase in share prices.

Market Perception:

• While right issues are often seen positively, frequent use can signal financial distress, impacting market perception.

Key Considerations for Companies

To successfully navigate a right issue, companies need to consider several factors:

• Timing: Evaluating market conditions and the company’s financial status to determine the optimal timing.
• Pricing Strategy: Setting an attractive discount that balances the interests of the company and its shareholders.
• Communication: Ensuring clear and transparent communication with shareholders to foster trust and encourage participation.

Eligibility Criteria For Right Issue

• Existing Company Status: The company must be an existing public or private company with already issued shares. The rights issue is offered only to existing shareholders.

• Board Approval: The company must obtain approval from its Board of Directors for the rights issue, including determining the terms, price, and ratio of the offer.

• Shareholder Approval: Shareholder approval is required through a resolution passed in a general meeting or through a postal ballot if required by the company’s articles of association or regulatory requirements.

• No Default in Debt Obligations: Companies must not have defaulted on payment of interest or repayment of principal on loans from financial institutions or banks. This is particularly scrutinized for listed companies under SEBI norms.

• Financial Statements: The company should have its financial statements prepared and audited as per regulatory norms, reflecting the company’s financial position to inform shareholders adequately.

• Disclosure Requirements: The company must provide a detailed letter of offer to shareholders, including all relevant information about the purpose of the fundraise, financial details, risks, and use of proceeds.

Steps to Implement a Right Issue

Implementing a right issue involves several key steps:

• Board Approval: Obtain approval from the company’s board of directors.
• Regulatory Compliance: Adhere to all legal requirements, such as those set by SEBI in India.
• Subscription and Allotment: Facilitate the subscription process and allot shares accordingly.

Legal and Regulatory Framework

Navigating the legal landscape is essential for a successful right issue:

• SEBI Regulations (India): Compliance with regulations concerning disclosures, pricing, and timelines.
• Disclosure Requirements: Transparent communication of the right issue’s terms and potential risks.
• Compliance Checklist: A structured approach to ensure all legal aspects are addressed. Companies can also opt for Compliance Audit to ensure the adherence to all legal compliances.

Potential Risks and Challenges

Right issues, while beneficial, also come with potential pitfalls:

• Risk of Undersubscription: Not all shareholders may subscribe, leading to less capital raised than anticipated.
• Dilution Risks: Non-participating shareholders will see their ownership percentage decrease.
• Market Sensitivity: Poor market conditions can negatively impact the right issue's success.

Preparing for a Right Issue

Proper preparation can make the difference between a successful and unsuccessful right issue:

• Financial Analysis: Conduct a thorough Financial Analysis of entity to determine the capital required and the optimal pricing strategy.
• Engaging Experts: Consultants can provide valuable guidance throughout the process.
• Strategic Communication: Keeping shareholders informed and engaged is key to driving participation.

Role of Right Issue Consultants

Right issue consultants like GenZCFO offer essential support to companies through expert advice and operational assistance:

• Expert Guidance: Consultants provide in-depth knowledge and experience, ensuring the right issue is executed flawlessly.
• Regulatory Navigation: Handling all compliance aspects, from initial planning to execution.
• Streamlined Process: Consultants help simplify the right issue process, reducing the burden on the company.

GenZCFO specializes in guiding companies through right issues, providing expert consultancy that simplifies the process. Beyond right issue consultancy, GenZCFO offers a suite of services that support companies in various financial aspects usch as Dividend Consultancy, Private Equity Consultancy, Budgeting, Cash Flow Planning, Project CFO Services, etc.

If you have any query related to Right Issue or any kind of consultation services, kindly contact us, our team of Experts will be delighted to assist you.