What is a rights issue? – effect on share price?
During the last year or so we starting to see companies performing ‘Rights Issue’ – to some this is a completely new concept.
A rights issue is basically when a company issues more shares to existing shareholders in order to raise new capital for the business.
Usually you find that when there’s a rights issue, existing shareholders are given ‘rights’ to the new shares, on a ratio of say 2 new shares for every share you currently own. Shareholders offered rights are sometimes allowed to sell their rights to other shareholders.
Share Price -
Share price is determined by the demand for shares (people wanting to buy them) and the supply (people who want to sell shares and how many shares are in issue).
Now, a rights issue is where the business issues more shares, this increases the quantity of shares available (supply). This drives down the share price as there are no many millions more available. So you could have a share price at £2 (200p) and then it falls to 60p as the current proportion that you own is diluted.
Still Don’t Understand?
A company is worth £100m with 100 million shares in issue, so share price is currently at £1.
The business wants to raise money from a rights issue, they sell 100 million more shares, making the total in issue 200 million. The share price will fall to 5op at 200 million shares which gives the company value of £100m.
Now, that’s simple way above but you may find that the share price will increase over time to reflect the business now has more capital in it’s balance sheet, which makes it appear the company’s worth more.
Also you find that rights issue shares are offered below that of market value to reflect the dilution of the share price from issuing more shares. It’s also cheaper to try and encourage people to buy more shares.
Long the Run
Now in the long-run the idea is that the new capital raised can be invested in the company, either to pay off debt or to help expansion etc. This should make the business more profitable in the long-run and for share price to increase.
