Advantages and Disadvantages of Right Issue of shares
The right issue of shares is an extravagant method to raise capital of the listed companies. When a company undergoes liquidity crises, it summons the existing shareholders for additional money in exchange for an issue of shares at discounted prices. Thus, such an issue is referred to as right issue. During the process of right issue, a company provides shares at a minimal price than its market value. Like a blessing comes along a disguised curse, there are certain advantages and disadvantages of right issue, so this blog will cover them all.
Key Features of a Right Issue
These are some apparent characteristics of right issue of shares:
- It enables the existing shareholders to trade with the other interested participants until a specified date on which the new shares are purchasable. The right issue of trade is similar to equity shares trade.
- A company during the right issue of shares gives preferential treatment to its existing shareholders. Thereby the shareholders avail the right to buy additional shares at affordable prices before a specified date.
- In the right issue, the number of additional shares purchased by an existing shareholder is always in proportion to his existing shareholding.
- Moreover, the existing shareholders get leverage to dismiss the right issue. Besides, if a shareholder chooses not to purchase the additional shares, then his existing shareholding shall get diluted after the issuance of additional shares.
- A company can initiate the right issues only at indigent times without incurring underwriting fees.
Considerable Advantages of Right Issue of Shares
The right issue creates a win-win situation for both the company and its shareholders. As the company get access to the required funds and the shareholders have the power to purchase shares at lower prices corresponding to their percentage holding in the company. Have a look at the perks of using the right issue over other modes of fund-raising:
- Fastest Method of Raising Capital- unlike public offerings, the right issue involves less rigorous rules and regulation as it is more of an internal matter. The only protocol that persists in the right issue is that the listed companies file a letter of offer with SEBI and stock exchanges for public comments to obtain approval before they issue new shares.
- Inflation of Promoter Shareholding- the factor which turns out to be an enormous benefit of the right issue is that it helps promoters to increase their shareholding. The shareholders can subscribe to an ‘unsubscribed portion’ of the issue, which elevates their shareholding.
- Record Date and Pricing- in order to reckon the eligible shareholders who can participate in the rights issue, companies announce a record date. It helps the companies to issue rights and reward their shareholders with low-priced shares. Moreover, it further avails them to raise the required capital with maximum subscriptions.
- No Scope of Debt– it goes without saying that the right issue is the most secure fundraising method. It acts as a favourable gateway to raise capital wherein the company can expand its business without any simultaneous increase in debt. Through the right issue, a company raises the desired money from its existing shareholders without modifying any terms of percentage holdings of members. Thus, it eliminates any scope for debt.
Drawbacks of Right Issue for a Company
Although the right issue is undeniably the cheapest source which helps a company to attain the required funds, yet sometimes the companies have to snag the downside of it. Here are the most common limitations of right issue:
- Raise capital up to a confined limit- An apparent drawback of such an issue is that a company cannot raise an amount in case of (IPOs) Initial Public Offering. Mostly, stock exchanges put a restriction on the amount on which a company can raise via the right issue. Also, the limit is usually proportional to the existing equity value of the company. Thereby in case, a company has undervalued stocks, then raising funds through the right issue might create pressure on the company.
- Value of each share may get diluted- At the time of issue of equity shares to raise money; there are chances of stake dilution of the existing shareholders. As the percentage shareholdings get reduced with the initiation of new shareholders, it turns out to be a troublesome situation for the existing shareholders.
- Diminish the company’s public image- Generally, the issue of right shares in an indication of liquidity crises that a company suffers. If a reputed firm issue right shares, then it creates a negative market sentiment. Thus, shareholders assume that the company is struggling to run its business operations smoothly.