Some companies may opt to issue rights or share warrants as an alternative form of capital generation.
Companies that need to raise additional capital may do so by issuing additional shares of stock. However, raising additional stocks may dilute the value of existing shares, which may be a concern for shareholders.
These tools enable shareholders to buy additional stock or shares directly from the company at a discounted price in general.
What is Stock Rights Issue?
The right issue is a market offer, wherein a company need not go public to raise further capital, instead it gives its current shareholders the right to subscribe to newly issued shares in proportion to their existing shares, usually at a discount to the market price.
It is the right that a shareholder may or may not exercise, but not an obligation to buy the shares.
In order to determine the eligibility for the rights issue, a company announces the record date. All the shareholders having shares of the company as on the record date becomes eligible to qualify as an existing shareholder for the rights issue.
Since the issue of rights results in a higher equity base for the organization, it provides better opportunities for leveraging. The company in this case can raise more debt and still have favourable Debt to Equity ratio.
Value of a right issue
For instance: A company XYZ ltd. proposes rights issue to its existing shareholders instead of going to public. The company offers two new share for every two shares held by the shareholder. The market value of the share is Rs. 250 and the company is offering one share for Rs. 130 each.
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Price of rights shares
| Market value of the shares already held by shareholder (Rs. 250 x 2 shares) | Rs. 500 |
| Add: Price to be paid for buying two share | Rs. 260 |
| Total shares (4 shares) | Rs. 760 |
Average price of one share = Rs 760 / 4= Rs. 190
Value of the Right = Market Value – Average Price
= Rs. 250 – Rs. 190
Value of right = Rs. 60
Thus a company brings a rights issue to pay off its debts or for expansion plans at zero cost.
Share Warrants
A stock warrant gives the investor the right to purchase a company’s stock at a specific price and on a specific date, however, once the time elapses it becomes worthless. The stock is issued directly by the company, and not by any third party.The money received on exercising warrants is a source of capital for the company.
Share Warrants are long term instruments which allow shareholders to purchase additional shares at a discounted price, till certain date but are usually issued at an exercise price higher than the current market price. Share Warrants are dilutive, and an investor receives newly issued shares rather than the shares that are already outstanding.
Investors holding share warrants do not have voting rights nor are they entitled to any dividends from the company.
For instance, as a valued investor or employee of a company, you are issued a stock warrant that enables you to purchase XYZ Corp at Rs. 20 per share exercise price. So the warrant contract is executed on the exercise date and XYZ Corp is bought for Rs. 20, even if it is not trading at that price on that day. You are then given one share of XYZ Corp stock in return. Consequently, you’ve already made a profit on the deal if the stock is selling at Rs. 30 per share.
On the other hand, if the XYZ Corp underlying stock price falls to Rs. 10 per share, you’re “out of the money, because the strike price is Rs.20 which is considerably higher than the actual stock price at which the stock is selling.
Advantages and Disadvantages.
- The money so derived from the rights normally lets promoters improve their working capital requirement in the company or allows paying debt or buying plant and machinery.
- The shareholders participating in rights offer gains by purchasing additional shares at a reduced price from the prevailing market price.
- Under share warrants, there is a time lag within which the investor needs to exercise his warrants and he may or may not make profits on his investment if the share price does not rise.
- If a strong company issues rights shares, then it generates a negative feeling in the market. Shareholders, therefore, conclude that the firm might be struggling to smoothly operate its business operations.
- The rights issue increases the number of shares for the stock thereby affecting the return ratios.
- The share warrants are normally issued with bonds to make it more attractive for a longer period of time.
Key Takeaways
- The right issue is the way by which a company raises additional capital from its current shareholders.
- Unlike future or options, the value of share warrants is derived from underlying assets.
- Share Warrants help to diversify the portfolio as it is a cost-effective way of raising money.
- Share Warrants are the derivative that does not have any standardized terms.
Happy Learning!
