What Is a Rights Offering?

A rights offering takes place when a company needs to raise more money. Rather than offer shares to anyone, it gives current shareholders a chance to buy more stock during a fixed period.

How Does a Rights Offering Help?

This method lets shareholders keep their current level of ownership in the business while the company gets more capital. In most rights offerings, the existing shareholders get a discounted price for new stock purchases.

When a shareholder doesn't want to buy additional stock, he can transfer the rights on the open market, giving someone else a chance to buy company stock at a discounted price. Since the offering rate is low, the company is likely to sell most or all of its newly available stock.

The ability to transfer means that if a current stockholder doesn't want to buy more, he can easily find someone who will. The only catch is that the third party must buy within the fixed time frame of the rights offering.

How Does a Rights Offering Issue Work?

When a business does a rights offering, it is giving each shareholder the chance to buy one right for each share owned. The shareholders have no requirement to do anything. They can buy the maximum number of shares based on the rights issued. They can buy some shares but not enough to keep their current level of ownership. They can even pass on the rights offering completely. In most cases, those with shareholder rights don't pass, though. They either buy more or they transfer eligibility to someone else with an interest in owning shares of the business.

Sometimes, a company will include an oversubscription privilege. This choice lets shareholders increase their ownership interest in the company. When a rights offering doesn't lead to the sale of all outstanding shares, a shareholder can buy the extras. In the process, that shareholder gains a larger investment share. The company sets the rate, usually one additional share for every four rights owned.

Here is an example of a rights offering issue. A company has shares that have a current value of $10. In order to get more money, it asks existing shareholders to buy more stock. The company offers a discount of $8 per share as an incentive to the current shareholders.

These investors have a set time frame, known as an expiration date, to buy the stock or let someone else take their place. The expiration date is generally one to three months from the announcement date of the rights offering.

An actual example occurred in 2016. Full House Resorts, which trades as FLL on the New York Stock Exchange, had a rights offering. It didn't allow the transfer or purchase rights, though. The company sold shares of FLL at a steep discount of $1.30 each, with a maximum of roughly 3.8 million common shares available. It did allow current investors to buy more stock beyond their current ownership interest. This is a process known as over-subscription rights.

Investors had the opportunity to buy new shares starting on the announcement date, August 25, 2016. The expiration date for purchase buying shares was October 28, 2016.

Shareholders had good reason to buy more stock. FLL was trading at $1.84 on the announcement date. Each share had a discount of $0.54. The company's market cap was roughly $35 million that day.

FLL sold $5 million worth of stock. That money helped to secure the company's position in its industry. The shareholders were able to increase their investment in the company. Meanwhile, the value of the stock price only dropped slightly. It finished at $1.75. FLL gained $5 million at a cost of 9 cents per share.

What Are the Benefits of a Rights Offering?

During a company's early days, cash flow is a regular problem. A rights offering gives the company a chance to add more money without changing the current ownership holdings. This strategy is also a good way to pay off debt or buy a different company. It's also useful at times when banks are unwilling to offer a line of credit. During a down economy, a rights offering is a great way to raise funds internally.

A rights offering can save a business a lot of money. Nobody pays underwriting fees in a standard rights offering. In some instances, a company will choose to use an underwriter. When that happens, the underwriter agrees to buy shares at the subscription price. This is called an insured rights offering.

Many shareholders are happy to participate in a rights offering. An owner can add more shares to his current holdings. Alternately, this person can transfer status to someone else, who will gladly buy discounted stock in the business.

How Does an Insured Rights Offering Work?

The underwriter gets to buy from the pool of unpurchased shares. These are the rights in the rights offering that existing investors choose not to purchase. This kind of plan is a standby risk agreement. The underwriter usually earns commission on all new shares in the rights offering.

In some cases, an underwriter isn't the party insuring the rights offering. An affiliate of the company, an investment bank, or an affiliate of an investment bank could do it instead. An insured rights offering is also known as a standby commitment or backstop commitment.

What Are the Negatives of a Rights Offering?

When a company needs more money, it has other options other than a rights offering. Outsiders will view this discounting of shares as a sign that the company has cash flow problems. Otherwise, it wouldn't sell more stock at a discounted rate.

Some shareholders also don't like a rights offering. Their two options are to buy more stock or to have their current ownership interest reduced.

Rights offerings and warrants aren't as popular as additional stock offerings. A healthy company usually sells more stock on the open market. That's why analysts view rights offerings as a sign of weakness.

Finally, companies can make mistakes during rights offerings. When that happens, they give away a larger share of ownership without gaining anything in return. Accurate filings are crucial during a rights offering.

What Steps Should a Company Take during a Rights Offering?

The key steps are:

  • Giving the investors information about the plan
  • Providing documents about the rights offering
  • Selling the investors on the benefits of buying more stock
  • Collecting payments from shareholders
  • Collecting documents from shareholders
  • Filing all paperwork with the securities exchange commission (SEC)
  • Filing all paperwork with any other governing body

How Long Have Rights Offerings Existed?

The concept of a rights offering is centuries old. The first known example was in the 1600s. The London Stock Exchange used the concept as a way to reward investors. It remains a popular practice in England today. It's not viewed as favorably in the United States, though. In 1999 and 2000, only about 40 companies held rights offerings. They raised about $3.4 billion in new capital from existing investors.

What Are Rights?

Stockholders can't just buy more shares of any company whenever they want. Rules apply for different types of businesses. Rights are what a company gives shareholders to let them buy more stock. The rights are for the purchase of more ownership interest at a set price. Usually, this price is below market value as a way to reward the stockholders for their prior investments.

Also, the company limits the amount of time a stockholder has to buy at the lower price. Otherwise, they'd set the market for the value of their shares at this low rate, something no business wants. A company may also refer to rights by other, longer terms such as share purchase rights or subscription rights. The process works the same no matter how a business refers to it.

Someone can trade a right whether it's listed on an exchange or not. This kind of transaction is independent of the exchange. The price of a right depends on several factors including market volatility, expiration date of the offering, and the current interest rate.

What Is a Subscription Rate?

As mentioned, a shareholder expects to hold the same percentage of ownership interest as a company grows. The subscription rate is the rule that makes sure that an investor can do so. It gives the stockholder the right to buy new stocks at or below current market pricing. The rights offering is the way that companies honor the subscription rate. Note that preemptive right and subscription privilege are other terms for subscription rate.

What Is a Subscription Price?

This is the static price of a rights offering. The shareholder pays this amount per right to maintain the current level of ownership in the company. The subscription price of the rights offering is the same for all shareholders.

In some instances, the static price describes a warrant. Warrant holders will have the right to buy warrants at a subscription price.

What's the Difference between Transferable and Non-Transferable Rights?

Transferable rights exist when a shareholder has the option to let someone else purchase stock during a rights offering. Non-transferable rights are the opposite. A company chooses not to allow outside interests to become new owners in the company. Non-transferable rights aren't eligible in trade. Transferable rights are. Despite this, businesses use non-transferable rights more often during rights offerings.

How Long Does a Rights Offering Remain Open?

Every offering is different. The standard rule is somewhere between 16 and 30 days. Federal securities laws don't require any set time frame, though. The timer begins when the company releases a rights offering registration statement.

How Does an Investor Step Up?

Investors who own fractional shares in companies fall under a special class. The rule is that a person gets one right per share owned. With fractional shares, investors get to use the step-up privilege. These shareholders get to buy an extra right. They gain a slightly larger ownership interest. From the company's point of view, the investor now owns a full rather than fractional amount of shares. That's easier for everyone.

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