When a company needs more capital, there are a number of options available. One is a ‘rights issue’ or rights offer, which involves offering existing shareholders the opportunity to buy further shares in the company.
There are a number of factors to bear in mind before taking part in such an offer, including why the company needs the capital. It may be because it needs money to grow or is facing challenging conditions; for example, a number of listed companies may need to raise capital due to the COVID-19 pandemic.
**Capital raising rules eased due to COVID-19**
On 19 March 2020, the NZX announced a temporary easing of rules around equity capital raising, to help listed companies "weather the impacts of COVID-19".
Changes included shorter timeframes for rights issues, and higher limits on the amount of shares that can be issued without shareholder approval. NZX said companies "will be encouraged to recognise the interests of existing investors, for example allowing existing equity security holders the opportunity to participate to avoid dilution". For more, see the NZX announcement here.
The ‘right’ to purchase more shares
When capital is raised through a rights issue, existing shareholders are given the right to buy more shares, in proportion to the amount they already own, and often at a discounted price.
There is usually a maximum amount of shares you will have the opportunity to buy, for example one more for every five you own. You don’t have to buy the full amount, though, or any if you choose not to take part.
A key issue with such capital raises is “dilution” – the decrease of an existing shareholder’s percentage ownership in a company. Only in the rare case that all shareholders choose to participate fully in a rights issue, will they all end up retaining the same percentage holding of the company and there will be no dilution – albeit at their own extra expense.
Shareholders can chose to participate in part or not at all. Those who don’t participate will have their percentage holding of the company diluted if the rights issue is successfully completed.
There are two types of rights issues: renounceable and non-renounceable. Renounceable means that, instead of utilising your rights, you can sell them to someone else, who will then be able to purchase your share entitlement. Rights are sometimes listed on the NZX and can be sold like ordinary shares. Non-renounceable means that the right is not transferable, and therefore cannot be sold.
Always review the offer before taking part
Companies raising capital via a rights offer may send existing shareholders an offer document, or can just make an announcement via the NZX.
What you can expect to be told by the company:
- The ratio of shares you can buy based on your existing holding, eg 1 for every 5
- If you can sell/renounce your allotted rights before you purchase them
- The price of each individual share on offer, eg $1.50
- The total amount of money the company is trying to raise
- The maximum amount of shares to be issued
- The deadline for accepting the offer
- Why it is raising capital, eg to buy new assets or pay down debt
- If, and by how much, the market price of each share is being discounted
- What the company will do if too few or too many existing shareholders take up the offer
When deciding on any capital raising, company directors are required to act in the best interests of the company. This includes balancing a range of considerations such as its need for capital, and impacts of the offer on existing shareholders, including possible dilution of their holdings.
Consider whether the company’s rationale for the offer is a good reason to invest
The most common reasons a company might be raising capital include:
- Needing money to grow. To lease better premises or hire new staff, for example, or buy new technology or machinery, or a merger or acquisition
- To pay off or avoid debt. The company may need the extra money to pay off existing debt, or may not want or be able to borrow more
- It is facing difficult times. Falling revenue or rising costs, for example, or fresh challenges for its industry, sector or the wider economy
Bear in mind the risks involved in such offers:
- The company could be in difficulty. Too much debt or challenging economic conditions, for example, hence the need to go back to its owners (i.e.: its shareholders) for more money to stay afloat.
- Whether the offer dilutes the value of your existing shares if you don’t take part. By injecting new shares into the market, the company is redistributing value and generally decreasing the value of individual shares. To maintain your relative shareholding, and any associated rights such as voting, you would likely need to take up all rights on offer.
Also, think about your overall investment portfolio:
- Do you want to increase your investment in this company? How does increasing the size of your investment in this company fit with your overall investment portfolio and strategy.
The company will explain how to take up the offer
Buying
In its offer document and/or market announcement, the company should provide instructions on how to buy all or part of your entitlement, usually via a form to be completed and sent in, and how to pay.
After the closing date, the company will tell you how many new shares you have been issued.
If the offer cannot be completed because not enough existing shareholders have participated or not enough capital could be raised, the company will typically communicate the alternatives that will be pursued to raise the desired capital, such as extending the offer to new investors.
Selling
In a rights issue that’s renounceable, you may wish to sell all or part of your entitlement of shares. The company should advise when and how you can sell your rights.
To decline the offer simply take no further action
Note, if you don’t participate while other shareholders do, your percentage shareholding in the company will decrease.
The company might not get its target amount of capital
If not enough existing shareholders take up the rights offer, new investors may then be offered shares.
Other types of capital raising can affect your investment
A placement is a direct offer of shares to mostly larger, institutional investors, individual shareholders, or a combination of both. Existing shareholders do not, by right, get the opportunity to participate. This means their percentage shareholding may be diluted.
Terminology
Dilution: occurs when a company issues new shares which results in a decrease of an existing shareholder's percentage ownership of that company
Entitlement ratio: the number of new shares you can buy. Usually “pro rata” i.e. a ratio of what you already own, eg “1 for 6” means one extra share for every six you own
Issue price: the price of each additional share on offer
Offer size: the total amount of money the company is trying to raise
Offer discount: how much the market share price has been discounted
Renounceable rights: can be traded separately from the original shares held
Shortfall: where the company fails to sell enough shares under the rights offer
Shortfall offer: where the company re-offers shares that other shareholders haven’t taken up
Underwriting: an institutional investor guarantees that they will buy any shortfall shares that aren’t taken up
VWAP: the volume weighted average price a share has traded at over a given time period, often used as a benchmark to indicate the amount the shares have been discounted.
