What Is a Rights Offering Issue?

Rights Offering Issues Explained

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A rights offering issue happens when a company offers new shares to its current shareholders. This increases the number of shares, diluting their value, but also lets each investor buy enough shares to maintain their current stake in the company. It is a way for a company to raise capital.

Learn more about how a rights offering issue works and whether you should take advantage of one if you have the chance.

Definition and Example of Rights Offering Issue

A rights offering issue is the process of a public company giving its current shareholders the right to buy additional shares. These are often offered at a discount. A company might issue a rights offering when it needs to raise additional capital. This type of offer lowers the value of shares because it creates more of them. But it also gives investors the chance to maintain their current stake in the company if they buy more shares.

A recent example of a rights offering issue occurred with the popular meal subscription service Blue Apron. On Sept. 21, 2021, the company filed a registration statement with the U.S. Securities and Exchange Commission (SEC) to share that it would be issuing a rights offering. The company planned to raise $45 million by issuing its shareholders:

  • One warrant to purchase a share of Class A common stock for $15
  • One warrant to purchase a share of Class A common stock for $18
  • One warrant to purchase a share of Class A common stock for $20

Companies can use the money they raise from a rights offering in a variety of ways. According to Blue Apron’s filing, the company planned to use the money to accelerate growth; build on its environmental, social, and governance (ESG) program; provide working capital; and other general corporate purposes. The company also planned to use up to $5 million of the funds to pay down debt.

How Does a Rights Offering Issue Work?

When a company needs to raise additional capital, it can do so in several ways. One is to issue more shares of stock. For a rights offering issue, a company issues new shares of stock and offers them to people who are already shareholders.

When a company issues a rights offering, the price of new stock often comes with a discount. To use the discount, you would have to make your purchase by the expiration date that the company sets. In some cases, you might be able to sell your right on the open market. At other times, the rules of the rights offering might prevent that.

Sometimes, a company issues rights in the form of warrants. A warrant is a type of security that gives you the right, but not the obligation, to buy a specific security at a predetermined price (called the exercise price or strike price) before an expiration date.

A key component of rights offerings is that the number of shares you have the right to purchase is proportional to your current stake in the company. That way, if you choose to exercise your right, you’ll end up with the same percentage of ownership that you had before the new shares were issued. If you choose not to purchase the shares, though, you’ll end up with a smaller stake in the company.

Types of Rights Offering Issues

When a company decides to issue a rights offering, it will choose between two types: a direct rights offering and an insured rights offering.

Direct Rights Offering

In a direct rights offering, a company issues rights to its shareholders and sells only the shares that its shareholders choose to buy. If some of the rights go unexercised, the company simply doesn’t sell those shares.

This type of offering could result in a company raising less capital than planned. A direct rights offering is best for companies that want to raise capital but don’t have a specific amount that they must end up with.

Insured Rights Offering

For an insured rights offering, the issuing company works with a third party such as an investment bank to insure the shares. In this type of offering, each shareholder has the same right to purchase additional shares. But if any shareholders choose not to exercise their right, then the third party who has insured the shares will purchase them instead.

With this type of offering, the issuing company is guaranteed to raise the capital that it planned for. This type of rights offering is best for companies that need a specific amount of capital or would rather have a guaranteed result.

Pros and Cons of Rights Offering Issues

  • Allows the issuing company to raise capital

  • Allows shareholders to maintain their current stake

  • More affordable for the issuing company

  • Dilution of the existing shares

  • Reduces stake of non-participating shareholders

  • Could result in less capital raise than the company hoped

Pros Explained

  • Allows the issuing company to raise capital: For companies that need additional capital for growth, capital expenditures, and other purposes, a rights offering can be an effective way to get it.
  • Allows shareholders to maintain their current stake: As a shareholder, you’re offered a number of shares proportional to your stake in the company. You can maintain your current share of ownership if you choose.
  • More affordable for the issuing company: Rights offerings can be more affordable than other equity issues for several reasons, including lower administrative costs and less marketing.

Cons Explained

  • Dilution of the existing shares: Because a rights offering increases the number of a company’s outstanding shares, but not the value of the company, the value of each existing share is diluted.
  • Reduces stake of non-participating shareholders: If you don’t purchase the shares you are offered, your stake in the company will reduce.
  • Could result in less capital raise than the company hoped: In the case of a direct rights offering, the company only sells as many shares as its shareholders choose to buy. This could be fewer than the company planned to sell.

What It Means for Individual Investors

If you are an individual investor, a company that you’re a shareholder in may issue a rights offering. You’ll have the chance to buy additional shares. Should you exercise that right?

You can purchase additional shares, but you don’t have to. If you choose not to purchase additional shares, though, you’ll reduce your stake in the company. This means you’ll own less of the company than you used to.

For example, suppose Corporation XYZ has 100 shares held equally by 10 shareholders. Each shareholder is given the right to purchase five more shares. Before the rights offering, each shareholder owned 10% of the company. If each shareholder buys the five new shares, they’ll still each own 10%. However, if everyone but you buys new shares, they will suddenly own more than 10%, and you’ll own less.

The good news is that you have more options than simply exercising or not exercising this right. If you have the right to purchase additional shares and decide it’s not the right decision for you, you may be able to sell your right on the open market. This would allow you to earn a profit, even if your ownership stake decreases.

Key Takeaways

  • A rights offering issue occurs when a company offers new shares of stock to its existing shareholders, often at a discount.
  • Rights are generally offered in proportion to the amount of ownership each shareholder already has in the company.
  • There are two types of rights offerings: direct rights offerings and insured rights offerings.
  • In a rights offering, you can buy and keep your ownership stake, let the right expire and find your stake reduced, or sell the right and earn a profit.