Floor Price in a Rights Issue

A floor price in a rights issue is the subscription price at which existing shareholders can buy new shares—always set below the current market price. This discount is the incentive mechanism: by offering a bargain to loyal shareholders, the company increases the odds that enough rights will be exercised to fund the capital raise, and the steeper the discount, the harder it is for shareholders to leave money on the table.

What a Rights Issue Is

When a public company needs cash without tapping banks, it often issues new shares directly to existing shareholders, proportional to what they already own. A rights issue is a primary market capital raise: the company sells fresh stock at a set price, and shareholders receive tradable rights certificates that let them buy at that bargain rate.

The floor price is the non-negotiable subscription price. If the stock trades at $50, the company might set the floor at $40—a 20% discount—and give each shareholder the right to buy one new share at $40 for every five they own. Shareholders can exercise (buy), sell the right to someone else, or let it expire.

The Economics of the Discount

The floor price discount serves two functions. First, it makes the deal attractive to existing shareholders, offsetting their dilution. If you own 1,000 shares worth $50 and the company issues one new share for every five, you face dilution—your ownership percentage falls. But if you can buy that new share at $40, you’ve locked in a 20% gain, which partially compensates for the dilution hit.

Second, and more important operationally, the discount ensures strong takeup. A company cannot force shareholders to buy; it can only persuade them. A deep discount raises the odds that the rights issue will be fully subscribed. If too few rights are exercised, the company must find other buyers (called a backstop or underwriter) at a loss.

The size of the discount is calibrated. Too small, and many shareholders ignore the opportunity, forcing the company to rely on underwriters and pay underwriting fees. Too large, and the company dilutes existing shareholders more than necessary. Best practice across markets is a discount of 15–25%, though it varies by market conditions, sector, and shareholder base.

Calculating the Floor Price

There is no universal formula; the board and management decide. However, the floor is typically set a few percentage points below the average share price over the preceding weeks or months, sometimes with a margin of safety built in.

Consider a stylized example:

A shareholder with 5,000 shares receives the right to buy 1,000 new shares at $40. She can:

• Exercise and buy all 1,000 at $40 (investing $40,000)
• Sell the rights to another investor
• Do nothing and let them expire

Why Not Set the Floor at Market Price?

If the floor were $50 (the current market price), there would be no incentive to subscribe. Rationally indifferent investors would skip the offering and let underwriters pick up the slack. Rights issues with tight discounts—or rights offering at-market—have been tried and fail: takeup is poor, and the underwriter ends up holding large blocks.

The discount creates urgency: every dollar the floor is below the market price is a profit opportunity for the exercising shareholder. This behavioral nudge is remarkably effective, especially among retail shareholders who see the deal as a bargain.

Dilution and the Pricing Paradox

There is a counterintuitive tension here. The deeper the discount, the more new shares the company must issue to raise the same amount of cash. If the company needs $80 million:

• At a $40 floor, it must issue 2 million shares.
• At a $30 floor, it must issue ~2.67 million shares.

This higher volume of new shares causes more dilution than a smaller, pricier issue would. But the company accepts this because the certainty of raising the full amount (via high takeup) outweighs the dilution cost. Better to raise $80 million and dilute by 20% than to raise $50 million and suffer the reputational and operational damage of a failed capital raise.

Post-Issue Stock Performance

After a rights issue closes, the stock often trades at or slightly above the floor price, not back at the pre-offer level. This is normal and reflects the dilution from the new shares. Shareholders who did not exercise their rights see their ownership percentage fall; shareholders who did exercise gain shares at a discount. Over time, the stock’s price reflects the company’s earnings power and growth prospects, not the capital raise itself.

Rights Trading and Separation

During the subscription period, shareholders can sell their rights in the secondary market. If you believe the floor price is too good to pass up but you need the cash, you sell the right to an institutional buyer or speculator. The right trades independently of the stock, often trading at a discount to the intrinsic value (the difference between the stock price and the floor) because of time decay and execution risk.

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