What Is A 'rights' Issue?

What Is A 'rights' Issue?

What a 'rights' issue means

APART from borrowing, whether by debenture (or loan stock) issues or from the bank, a public company can raise money by the issue of new ordinary shares for cash to existing shareholders. These shares are usually offered at below the current market price (never below par value) and the operation is known as a 'rights' issue.

The reason for making a 'rights' Issue

When a company needs more capital, to finance a planned extension or the additional plant or factories needed to meet increasing demands for its products, it must either borrow or raise it and the means chosen will be determined mainly by: (a) a comparison of interest rates with the effective cost of servicing new ordinary capital, (h) whether the finance is to be permanent or repayable after a period, (c) the amount of capital required.

Low interest rates favour borrowing if short term, bank borrowing and if long term, debentures or loan stock (or convertible debentures or loan stock). In the case of high interest rates and/or permanent requirements, a 'rights' issue might be called for. The cost of issue is also taken into consideration. Bank borrowing involves no issuing costs while debenture and 'rights' issues do. Again, the larger the additional capital required, the more likely is a 'rights' issue to be chosen. One not uncommon reason for a 'rights' issue is to repay a bank loan or overdraft. And, of course, in the final analysis a board might have no option but to raise cash from shareholders on a rights basis. Bank borrowing and debentures generally require some form of security and at a certain point the assets available might be inadequate.

The board's reasons for making a 'rights' issue are, therefore, entirely different from the ones for making a 'scrip' issue (Cf. previous webpage ).

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