10 Limitations Or Drawbacks Of A Company’s Rights Issue

Investors worried about the success of a rights issue.

Rights issue is not always beneficial for investors or firms. These limitations or drawbacks of a company’s rights issue can be hazardous for them.

Rights issue is a great issue of its own kind. It allows a company to raise required amount of funds for the company during difficult times.

In this issue, additional new shares are offered to existing shareholders in proportion to their shareholdings on record date. An attractive discount is usually offered in this issue of rights shares to make it successful.

In this sense, rights issue is not only a cheaper method to raise funds but also one of the quickest means to achieve firm’s objective. But, rights issue does carry certain disadvantages for the shareholders as well as the underlying company.

These disadvantages may affect both of them to a different extent at different times. Here are 10 disadvantages of a typical rights issue:

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(1) Rights Issue Could Raise Funds Only Up To Certain Limit Of Existing Equity Value Of Underlying Firm

It is one of the biggest limitations or drawbacks of a company’s rights issue. Rights issue is meant to raise funds for the publicly listed company from existing shareholders. But, a company can’t raise any amount as in the case of initial public issues (IPOs).

Most of the stock exchanges have put certain limit or restriction on the amount a company could raise through rights issue. This limit is usually decided on the basis of existing equity value of the firm.

For example, in India, Securities and Exchange Board of India (SEBI) allows a firm to raise funds only up to 25% of the existing equity value of the firm.

Therefore, if the stock price of a firm is undervalued during difficult times then it tends to put pressure on raising funds through rights issue.