Rights offering

A rights offering is an offering of newly issued shares to existing shareholders, giving them the right (not obligation) to purchase shares at a discount to the current market price, usually at a fixed ratio (e.g., one new share for every five shares held). Rights offerings allow existing shareholders to maintain their ownership percentage if they exercise, or to choose not to participate and accept dilution. They are less common in the US but standard in other countries.

How a rights offering works

A company wants to raise $500 million and has 1 billion shares outstanding. It conducts a 1-for-5 rights offering at a $95 discount to the $100 market price:

1. Announcement: Company announces that each shareholder will receive a “right” for every 5 shares held. The right can be exercised to buy 1 new share at $95.

2. Rights issuance: A shareholder holding 100 shares receives 20 rights (100 / 5 = 20).

3. Subscription period: Shareholders have, say, 3 weeks to exercise their rights (buy new shares). They can:

   • Exercise: Buy 20 shares at $95 each ($1,900 total) using their 20 rights.
   • Not exercise: Let the rights expire (lose the discount opportunity).
   • Sell rights: Sell their rights to other investors on the secondary market.

4. Allocation and pricing: If all shareholders exercise (fully subscribed), the company issues 200 million new shares and raises $19 billion. If subscription is low, the company may have unsubscribed shares that must be allocated (typically to investment banks or existing shareholders pro-rata).

5. Share adjustment: Existing shareholders who did not exercise are diluted (their ownership percentage declines). Shareholders who exercised maintain their percentage.

Shareholders’ choice

The genius of a rights offering is that it lets shareholders choose:

• Exercise pro-rata: Buy enough new shares to maintain your ownership % (dilution averted).
• Exercise partially: Buy some new shares, accept some dilution.
• Don’t exercise: Accept full dilution; let new shareholders buy.
• Sell rights: Let someone else exercise; you get cash from selling rights.

A shareholder who owns 1% before the offering and exercises fully still owns 1% after. A shareholder who doesn’t exercise sees their % decline to ~0.83% (if the offering is fully subscribed).

Why companies use rights offerings

Fairness: Existing shareholders get first chance at new shares at a discount, protecting them from immediate dilution.

Cost-effective: Lower underwriter fees (~1–2%) because the issue is directed to a known group (existing shareholders) rather than marketed broadly.

Shareholder preference: Some jurisdictions (Europe, Canada) require rights offerings or give companies incentives to offer them.

Alignment: Shareholders who believe in the company can vote for the rights offering and exercise; those skeptical can abstain.

Why rights offerings are rare in the US

• Perceived as desperate signal: A rights offering can signal that the company could not raise capital at fair terms in the public market (otherwise why not do a follow-on offering?).

• Partial underwriting needed: If subscription is low, the company needs an underwriter to buy unsubscribed shares (a “backstop”), adding cost and complexity.

• Shareholder apathy: Many retail shareholders ignore rights offerings and let rights expire, necessitating underwriter backstop.

• Legal complexity: Managing rights, expiration dates, and allocation is administratively complex.

US companies typically prefer traditional follow-on offerings or PIPE offerings, which are cleaner and faster.

Transferable rights

Rights are often transferable: a shareholder can sell their rights on a secondary market to other investors. This is useful for shareholders who don’t want to exercise but don’t want to let the discount opportunity go to waste.

The value of a right on the secondary market reflects:

• The discount (10% discount = ~5–10% value in the right).
• The likelihood of full subscription.
• The time value (a right expires on a fixed date).

Subscription ratios and valuations

The subscription ratio (e.g., 1 new share per 5 held) determines how much capital is raised:

• 1-for-5 ratio: 200 million new shares (20% increase in share count).
• 1-for-2 ratio: 500 million new shares (50% increase).

Higher ratios mean more dilution if unexercised, so the discount is typically larger to incentivize exercise.

Under-subscription and backstop arrangements

If the offering is under-subscribed (fewer shareholders exercise than expected), the company must deal with unsubscribed rights:

• Underwriter backstop: The underwriter (investment bank) commits to buy all unsubscribed shares at the exercise price.

• Standstill agreement: Existing shareholders (often large institutions) agree to exercise up to a certain amount to ensure minimum subscription.

The backstop fee is paid to the underwriter for assuming the risk that subscription is low.

Rights offerings and shareholder activism

If a rights offering is being proposed, shareholders may vote against it if they believe the discount is too steep or if they oppose the use of capital. However, in many jurisdictions, rights offerings are automatic rights (not optional) unless shareholders specifically oppose them.

Comparison to other offerings

• Follow-on offering: Company offers to the entire public market at current market price; faster; no shareholder choice; can result in greater dilution to existing shareholders.

• Rights offering: Shareholders get priority at a discount; slower; shareholder choice; less dilution if exercised.

• PIPE offering: Sales to institutions at discounted price; fast; no shareholder choice.

• At-the-market offering: Continuous sales at market price; no discount; gradual.

Rights offerings are most useful when the company wants to be fair to existing shareholders and can afford the slower timeline.