Additional Allocation of Rights Shares

July 12, 2022

INTRODUCTION:

Buying shares and trading in the shares have become more and more popular in past few decades. When invested mindfully they give huge returns on the investments. Shareholders can transfer their shares in the name of another or simply can sell the off, this can be done even if person is living in the other country. Such kind of transfers are regulated by Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, FEMA and FDI as well.

WHAT IS RIGHTS SHARE:

A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. This type of issue gives existing shareholders securities called rights. With the rights, the shareholder can purchase new shares at a discount to the market price on a stated future date. The company is giving shareholders a chance to increase their exposure to the stock at a discount price.

WHY RIGHTS SHARES ARE ISSUED:

It helps in raising additional capital.
Companies in need of money to pay off debts usually issues rights share in order to get money.
When launching new products company issues rights shares for getting more working capital.
For growth and expansion of the firm company needs money and it can be raised by the way of issuing rights shares.
For the purpose of acquisition (taking possession of another company).

ADVANTAGES OF ISSUING RIGHTS SHARES:

1. The right issue is a fast source of raising funds

Issuing rights is the fastest method and the cheapest source of raising capital for a firm. Our shareholders can buy new shares at a discount for a certain period on the right issue. The right issue involves less rigorous rules and regulations as it is more of an internal matter in the company.

2. The right issue incurs low cost

A company can initiate the rights issue process to its existing shareholders at indigent times without incurring underwriting fees. The company also saves money that is spent on advertising, underwriting fee, etc. The company does not have to incur such expenses compared with raising fresh equity from an IPO.

3. The right issue provides an option for the shareholders to maintain the same ownership

The number of additional share purchases allowed to an existing shareholder is always in proportion to his existing shareholding. Shareholders have the option to maintain their original proportion of share ownership.

Existing shareholders will have more certainty of getting shares, when a fresh issue is made to the existing shareholders, instead of the general public. The share price of the right issue will be less than the current share price which attracts the existing shareholders.

4. Raise funds without a form of debt

The right issue is a process to raise capital wherein the company can raise capital without any increase in debt. The company can raise the capital from its existing shareholders without altering the shareholder’s holding percentage. The scope of the right issue is purely in the form of equity and it eliminates any scope for debt.

5. The board of directors cannot misuse share issuing option

The board cannot misuse the opportunity of issuing new shares at a lower price. The right issue shares offered proportionately to the existing shareholders according to their existing holdings. Directors do not have much control over the right issue.

DISADVANTAGES OF ISSUING RIGHTS SHARES:

1. The existing shareholding percentage may get diluted

Existing shareholders have the option either to ‘subscribe’ to the right issue or ‘ignore’ to the right issue. If a shareholder ‘ignores’ the right issue then their shareholding percentage will get diluted. This is due to the extra shares issued by the company if it is ‘ignored’ by existing shareholders. If more shareholders ‘ignore’ the right issue then there are chances of stake dilution of the existing shareholders. As the existing shareholder percentage gets reduced with the initiation of new shareholders, it could be a troublesome situation for the existing shareholders.

2. After the right issue share price gets decrease

After the right issue, a certain percentage of shares will be newly introduced at a discounted price. This results in a dilution of the previous share price. Dilution occurs because a new large number share spreads the company’s net profit.

3. Limitation of fund raise

Most of the stock exchanges have put certain limits or restrictions on the amount of a company could raise through a rights issue. This limit is usually decided based on the existing equity value of the firm. The company cannot raise an amount compared to an IPO (Initial Public Offering). Raising funds through the right issue might create pressure on the company if a company has undervalued stocks.

4. The negative effect of the company’s public image

The right issue is an indication of liquidity crises that a company suffers. Generally, companies will practice the right issue option in the case of a financial crisis. The brand name of the company could negatively be affected when the right issue is announced. In another way, the shareholders also could assume that the company is struggling to run its business and could tend to sell their shares, which could then reduce the share price further.

PROCEDURE FOR RIGHTS ISSUE:

Issue of notice of Board meeting: According to Section 173(3) of the Companies Act 2013, the notice for the board meeting has to be sent minimum 7 days prior to the board meeting and must specify the agenda for the meeting.
Convene the First Board Meeting: The Board meeting is held, and the resolution for issuing rights shares is passed. The rights issue does not require the approval of shareholders, and hence the board can proceed towards the issue.
Issue Letter of Offer: On the passing of the resolution, the letter of offer is issued to all shareholders, and the same is sent through registered post or speed post. For shareholders to accept the offer a window period of 15 – 30 days is given that is to say the maximum time the shareholders can take to accept the offer is 30 days and the minimum period is 15 days. The offer is considered declined if it is not accepted before the expiry period. The offer must be open at least three days after the issue of the letter of offer.
File MGT – 14: After the passing of board resolution, the company must file the MGT -14 within 30 days of passing of the Board Resolution. The form MGT 14 is mandatory for a public limited company. A true certified copy of the Board Resolution needs to be attached to MGT 14.
Receive application money: The shareholders must send the accepted application along with application money.
Convene the Second Board Meeting: The company must convene the second board meeting, the notice of which must be sent 7 days prior to the board meeting. The required quorum must be present, and the resolution for the allotment of shares must be passed. On passing the resolution for allotment of shares, the allotment of shares must be done within 60 days of receiving the application money for the same.
File the forms with ROC: The company must file the Form PAS -3, within 30 days from the allotment of the shares with the Registrar of Companies. The certified true copy of the Board Resolution and the list of the allottees must be attached to the form. Additionally, the MGT – 14 must be filed for both the allotment and issue of shares.
Issue of Share Certificates: The share certificates must be issued; if the shares are in Demat form, then the company must inform the depository immediately on allotment of shares. If the shares are held in physical form, then the share certificates must be issued within 2 months from the date of allotment of shares. The share certificate must be signed by at least 2 directors. The share certificates must be issued in Form SH -1.

ADDITIONAL ALLOCATION OF RIGHTS SHARE BY RESIDENT TO NON-RESIDENT:

Existing non-resident shareholders are allowed to apply for issue of additional shares/fully, compulsorily and mandatorily convertible debentures/fully, compulsorily and mandatorily convertible preference shares over and above their rights share entitlements. The investee company can allot the additional rights share out of unsubscribed portion, subject to the condition that the overall issue of shares to non-residents in the total paid-up capital of the company does not exceed the sectoral cap.

REFERENCE:

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July 12, 2022