Rights issue is the best way to raise funds quickly. These possible reasons behind a company’s rights issue will help you to make better deals.
Rights issue is a form of invitation or offer to all existing shareholders to buy additional new shares in the company. These additional shares are usually priced at an attractive discount to the prevailing market price of the underlying stock.
These shares are offered to all existing shareholders as per the record date on pro-rate basis i.e. in proportion to existing shares. Therefore, there is no limitation on the amount of discount to be offered in a rights issue.
However, the company makes a final decision on the price & number of shares to be offered depending on the amount to be raised, prevailing market price, & existing outstanding shares.
When existing shareholders exercise their rights to purchase these additional new shares then the money goes directly to the company. This money collected is then utilized by the company management to meet its financial needs. Here are 10 possible reasons behind a company’s rights issue:
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(1) Reduce Burden Of Debt Either Partially Or Completely
It is one of the most common reasons for raising funds through a typical rights issue. Corporate debts are meant to raise financing for a firm for a variety of reasons. These are usually taken either for short-term or long-term scenarios.
According to a post published in Bloomberg, easy liquidity & underwriting along with low interest rates often contribute to a spike in the number of highly leveraged firms.
This creates a high risk of default on such firms. It is because companies are often subject to repay the principal amount at certain interest rate within a specified time frame.
However, several companies didn’t earn enough to pay even interest on their loans. These types of companies are often struggling with its existing debt may opt for rights issues.
Rights issue seems to be a quick cash fix for them to pay off their debt either partially or completely. These debt ridden companies even don’t hesitate to issue highly discounted shares in a rights issue.
This discount is often provided to mask the real reason for the company’s cash flow failing due to bad leadership. Therefore, investors are advised to analyze the true debt burden on a given company.
You should also analyze the ability of a company to perform well after debt reduction. If you find a positive answer then you should exercise your rights in the rights issue else it’s better to stay away.
- Reasons Behind Rights Issue: Shutterstock