If you choose not to take up a rights issue, your ownership stake in the company will be diluted. This means you will end up owning a smaller percentage of the company than you did before the rights issue.
What Happens If You Don't Take Up a Rights Issue?
When a company conducts a rights issue, it offers existing shareholders the opportunity to buy new shares, usually at a discounted price, in proportion to their current holdings. This is done to raise capital. If you decide not to participate and buy these new shares, the total number of shares in the company will increase, but your personal share count will remain the same. Consequently, your percentage ownership of the company will decrease, effectively diluting your stake. Investors who do take up their rights maintain their proportional share of the company, even though the company itself has more shares outstanding.
Share Dilution Explained
Share dilution occurs because the company issues new shares, increasing the total number of outstanding shares. Since your number of shares remains unchanged, your proportion of the total outstanding shares shrinks.
For example:
- Imagine a company has 1,000 shares outstanding, and you own 100 shares, giving you a 10% stake.
- The company issues a rights issue that doubles the number of shares to 2,000.
- If you don't participate, you still own 100 shares, but now 100 out of 2,000 shares is only a 5% stake. Your ownership has been diluted.
Financial Consequences
Not taking up a rights issue can have several financial implications for you as an investor:
- Dilution of Ownership Value: While the price of your existing shares might not immediately plummet, their value per share will theoretically adjust to reflect the new, lower average price per share after the discounted new shares are issued. This is often referred to as the Theoretical Ex-Rights Price (TERP).
- Lost Opportunity: You miss out on the opportunity to purchase shares at a discounted rate, which could have been profitable if the share price recovers or performs well in the future.
- Reduced Influence: A smaller ownership percentage might mean reduced voting power in company decisions if you hold voting shares.
Your Options Instead of Subscribing
Even if you don't wish to invest more money, you often have alternatives to simply letting your rights lapse:
- Selling Your Rights (Nil-Paid Rights):
- In many rights issues, the "rights" themselves are tradable on the stock exchange for a limited period. These are known as "nil-paid rights."
- You can sell these rights to other investors who do wish to buy the new shares.
- The proceeds from selling your rights can compensate you for some of the dilution effect, as the value of the rights reflects the discount at which the new shares are offered.
- Allowing Rights to Lapse:
- This is the simplest option: you do nothing.
- If you don't take up your rights or sell them by the deadline, they expire worthless.
- This results in full dilution of your stake without any financial compensation.
Pros and Cons of Not Taking Up a Rights Issue
| Aspect | Pros | Cons |
|---|---|---|
| Financial | No additional capital outlay | Dilution of ownership value |
| Potentially generate cash by selling rights | Loss of opportunity to buy discounted shares | |
| Ownership | Maintain current share count | Reduced percentage ownership of the company |
| Control/Influence | No change in existing voting power | Potential reduction in future voting power |
| Complexity | Simple (especially letting rights lapse) | Requires understanding of options (selling rights) |
Why Companies Conduct Rights Issues
Companies typically undertake rights issues to raise significant capital for various purposes, such as:
- Funding expansion projects
- Reducing debt
- Improving their financial position
- Investing in new technologies or acquisitions
Understanding these reasons can help you assess the long-term prospects of the company and inform your decision regarding the rights issue.
