What is a rights issue and how does it work?

The word 'rights issue' is a word you often come across in finance. But what exactly is a rights issue? In this article, we'll cover everything you need to know about the different types of rights issues and how they work.

What is a rights issue?

The most important thing you need to know is, of course, "What is a rights issue?" A rights issue is when a company invites the public or existing shareholders to buy more shares in the company. The company then decides to increase the number of shares in the company and sell them.

It is common for the subscription price of new issues to be lower than before in order to attract more buyers to invest in the company. A rights issue can be carried out by both a private limited company and a public limited company.

Different types of new issues

There are different types of rights issues that companies carry out for different purposes. Here are by far the most common types:

New share issue with preferential rights

A rights issue means that the shares are sold mainly to existing shareholders. This gives them preferential rights to invest in more shares, often at a lower price.

If you are not an existing shareholder, you may still have the chance to participate in a new share issue. But only if several of the shareholders want to sell their subscription rights. In that case, the company may choose to draw lots for the remaining shares that are not purchased among those who have expressed interest. If you are interested, it is therefore important to contact the company so that you do not miss the chance to buy shares from them. 

Open share issue

An open share issue is basically the opposite of a rights issue. Instead, the public is invited to participate in the rights issue and buy shares in the company. One reason why companies choose to have an open share issue is to create better brand awareness and allow a wide range of investors to invest.

Directed new share issue

So what is a private placement? A private placement means that the company itself has chosen to offer new shares only to a specific group. This could be, for example, a specific company/institution, specific investors, employees of the company, or investors who have shown interest in participating in previous share issues but have not been included for various reasons.

Why do you make a new share issue?

There are several reasons why a company chooses to issue new shares. But it's always because the company needs to raise new capital to finance something. They may need money because they want to:

• • Financing a specific venture or investment

• • Avoiding a possible bankruptcy

• • Financing an expansion

• • Buying up other companies

• • Avoiding borrowing money

Example of how a new share issue works

So what does a rights issue mean in practice and how does it work? It's easiest to explain step by step.

Step 1: The Board of Directors prepares and submits a proposal to carry out a rights issue.

Step 2: The general meeting/board of directors decides whether to carry out the rights issue.

Step 3: They also decide on the type of issue (rights issue, open or private placement).

Step 4: A subscription period for the rights issue is set (how long investors have to buy shares).

Step 5: The subscription period starts and an invitation with information is sent out.

Step 6: Respondents register their interest and are then allocated shares.

Step 7: Payment is made and the shares are registered at the Companies Office.

How to defend against dilution in a new share issue

It is not always obvious that an existing shareholder will want to participate in a rights issue. But what you need to be aware of is that if you, as an existing shareholder, choose not to participate in a rights issue, your stake in the company will be reduced after the issue is completed.

This is because the company has increased the number of shares it holds and if you don't buy more shares, the percentage you own in the company will be smaller after a new issue. This is called dilution and always happens when the number of shares in a company is increased.

You can defend your stake in the company by participating in the rights issue and buying more shares. In most new share issues, as an existing shareholder you have the right to defend your stake.

Buying into a company that has a rights issue

If you know that a company you are interested in often has rights issues, you can still register your interest if there are shares left over after existing shareholders have bought their shares.

It works the same way whether it is unlisted shares or shares in a listed company. Once you have invested in the company you are interested in, you will always receive information about future new issues.

Answers to frequently asked questions

How is a share price affected after a rights issue?

The share price can be affected both before and after a rights issue. However, if a company sells its shares for a cheaper price at the time of the rights issue, this means that the price of all shares will go down once the rights issue is completed.

Is a rights issue good or bad?

It can be both good and bad, it all depends on what the reason behind the new issue is. If it is done to invest in the purchase of another company or to invest in a venture, it is good. But if it is done to rescue a difficult financial situation, it is worse.

Is it good to participate in a rights issue?

In most cases, it is a good idea to participate in a new share issue precisely because you will have the chance to defend your stake in the company, given that you still believe in the company. If you do not participate, your share will be reduced in percentage terms as the number of shares in the company increases.

Can you buy whole companies via a rights issue?

No, a rights issue creates new shares that you can buy, but it is not an opportunity to buy an entire company. If you want to buy all the shares in a company, it is better to contact an investment bank that specializes in M&A if it is a larger company you want to buy. If it is a smaller company you want to buy, a business broker better.