So you’ve known by now that an IPO is a way for a company to raise capital by issuing shares to investors. A company issues an IPO only once in order to get listed on the stock exchange. This is why it is called an IPO, Initial Public Offering.
However, a company needs further investment regularly. If it can’t make up for this need from its profit or reserves, it issues another scheme to raise further capital. This scheme is called the rights issue.
Unlike an IPO, the rights issue is not open for all investors. As a gesture of gratitude to its existing investors, the company issues shares only to the investors who have already invested in the company. In a sense, the existing investors are entitled to a right to be able to invest when the company needs further capital. This is why this scheme is called the rights issue in the first place. The shares issued in a rights offering are called right shares.
1) At what price are the right shares issued?
Regardless of the stock price of a company, it should issue the right shares at its par value. The par value is also the price at which a company first issues its IPO. In the case of companies listed in NEPSE, Rs. 100 is the par value, with only a few exceptions.
Thus, if company A whose shares are being traded in NEPSE at Rs. 2,100 per share decides to issue right shares, it must issue at its par value, i.e.at Rs. 100 per share. This is why investing in the right shares is almost always profitable, oftentimes more profitable than investing in an IPO. This is also why a company’s share price tends to rise immediately after it unveils the decision to issue the right shares in the near future.
2) How do investors get the right shares?
We have talked about the book closure for dividends already. The concept of book closure date for the right shares is the same. After the board of directors of the company proposes the right shares to its investors, the decision has to be endorsed by the company’s upcoming AGM.
After the decision is endorsed and approved by the regulatory body (SEBON, NRB, Beema Samiti depending on the company’s sector), the company issues a public announcement declaring the book closure date. Investors maintained before the book closure date can apply for the right shares.
Do you get me? Only investors made eligible by this book closure system can apply for the right shares. If a company declares book closure on Jestha 05 for its right shares, you’ll have to buy the shares before that date and not sell till the book closure date to be eligible.
A common question I get is, what will happen if I sell the shares the next day after the book closure date?
You can sell the shares after the book closure date whenever you like and you will still be eligible to apply for the right shares. What matters is that you should be an investor in their books till the book closure date. Do you get me? Read it again if you did not.
3) Cool. And what is that percentage?
If you have noticed, the right shares are issued in percentage. For example, if company A wants to issue the right shares to its investors, it declares the amount of the right share in percentage, say 20%. What this means is, if the investor has 100 shares of the company, he can apply for 20 additional shares.
With this, he will contribute a total of Rs. 2,000 for the company, given that each share for most companies is issued at their par value of Rs. 100 in NEPSE.
Stepwise Right Shares Procedure Explained
1) Board of directors calls a meeting and decides on the matter.
2) Decision is approved by the regulatory body and endorsed by the AGM.
3) Company declares the book closure date and the date of issuance.
4) The issue is open during the issue date.
Note that the company gives ample time for investors to apply for the right shares. In general, the issue is open for 20 days. While NEPSE used to let the issue be open for 35 days previously, the right shares issues are now only open for 20 days.
20 days is a long enough time period, given that a company only gets 4 days to issue an IPO.
A company appoints an issue manager to handle all procedures relating to the issue of the right shares.
5) After the issue is closed, the issue manager allots the shares.
The issue manager then collects all the data, verifies it, and the appropriate quantity of shares is allotted to eligible investors. The tricky thing about right shares is that investors get exactly what they are supposed to get and no more. If 20% right shares are issued, an investor with 100 units of the company can apply for 20 rights shares and no more.
For numerous possible reasons, not all eligible investors claim their portion of the right shares. Some ignorant investors do not about the right shares procedure at all. Meanwhile, some applications have to be disqualified for various reasons. Some investors simply forget about the issue. After all, investors are humans. Humans are forgetful idiots.
This is why the issue is not fully subscribed. Thus, almost every time, the company has to auction the unsold shares.
6) The remnant shares are auctioned.
As I said, an issue of right shares is rarely fully subscribed. This is why a company has to auction the unclaimed shares. The good thing about an auction is that all investors are eligible to bid on it, regardless of whether they own the shares of the company.
However, the bad thing about an auction is that the highest bid is accepted. Only after allotting the shares to the highest bids, the remaining shares are allotted to lower bids. Thus, there is no chance of getting the shares at Rs. 100 per share. If more people are fighting to get the shares, they will bid higher, which might reduce profitability.
Nonetheless, for the company, auctioning the right shares is actually profitable. In a rights offering, the company only gets Rs. 100 per share. However, people bid higher in an auction. Thus, the company gets more investment for every share. This excess amount is chalked up as the Non-Operating income of the company. The company can use this amount to distribute dividends in the future.
7) The shares are listed in NEPSE and deposited to Demat accounts.
After both these process is completed, investors can trade these right shares in NEPSE just like they trade ordinary shares. In fact, after the issue, there is no distinction between right shares and ordinary shares.