What is a Rights Offering in a Stock Issuance?

Rights Offering takes place when a company offers additional stock shares for sale to its existing shareholders on a pro-rata basis. These additional shares of stocks are known as subscription warrants. 

Generally, the per share price of these stocks is set lower than the market price. These are generally transferable, and the shareholders may sell them in the open market. The purpose is for the company to raise additional funds.

How Does a Rights Offering Work? 

In a rights offering, the existing shareholders get the opportunity to buy the additional shares in proportion to their existing holding (but at a lower price). However, it is put to the shareholders if they want to exercise this right or not. There is no obligation. Two types of rights offerings are generally practiced by companies: 

What is a Direct Rights Offering? 

In a direct rights offering, the company only sells the number of exercised shares. If a right holder fails to exercise her option to purchase, there are no standby purchasers present in the system. Thus, the company only sells the same number of shares as needed by the existing shareholders who want to exercise the right. It may result in underfunding if a large number of the shareholders choose not to exercise the right. 

What is an Insured/standby rights offering? 

In standby rights offerings, the unexercised rights are offered to standby purchasers (commonly investment banks). These warrants are generally have a higher strike price than the warrants held by the shareholders. The purpose is to ensure the company gets its needed capital. 

Companies generally issue subscription warrants to raise funds for repaying debts, purchasing equipment, acquiring another company, or some other expenses. They may use the rights offering when there is no other viable option for raising funds. It allows them to raise funds without paying the underwriting fees. The approval of the existing shareholders is not needed to issue these stocks.

Although rights offerings allow existing shareholders to buy stock at a discounted rate, it may increase the risk of dilution. It may also lead to a more concentrated investor positions. It is not always a wise decision to issue these additional stocks to raise funds. It strictly depends on the situation in which the stocks are being issued by a company. Sometimes the cost involved in the process of filing the stocks is higher than its benefits.