What Is Nil-Paid?
Nil-paid is a security that is tradeable but originally posed no cost to the seller. For example, a renounceable right being sold by the original owner to another investor is considered nil-paid. A right is an opportunity to purchase more shares, usually at a discount, given to shareholders by a corporation. The shareholders receive these rights at no cost, and if the rights are renounceable, the shareholders can choose to sell them on the market.
- Nil-paid is a term that is usually applied to a rights issue, in which shareholders are given rights to buy new shares that a company is selling; because the shareholder doesn't pay immediately, the rights are "nil-paid."
- The rights are usually offered at a discount to what they would cost in the market in order to make them more attractive to shareholders.
- The shareholders can then choose to exercise the rights and buy them at the price they were offered; if they do this, the rights are then referred to as fully-paid rights, following the conclusion of the rights issues.
- If shareholders don't want to buy the shares, they can either allow them to expire or trade them on the market.
Though the word "nil-paid" may suggest that nil-paid rights give shareholders the right to acquire new shares for no cost, this is not the case. Nil-paid rights are only the right to acquire more shares at the current share price or a discount. The corporation issuing the rights to its shareholders does not receive payment for the rights, but if the shareholders decide to exercise the rights, they must pay for the securities they are given the right to buy.
Troubled companies often use rights offerings to raise money to pay down debt, but stable companies use rights offerings too—often to have the cash to fund more acquisitions.
To determine how much one might gain by selling the rights to shares held in a position, you need to estimate a value on the nil-paid rights ahead of time. Again, a precise number is difficult, but you can get a rough value by taking the value of the ex-rights price and subtracting the rights issue price. So, at the adjusted ex-rights price of $4.92 less $3, your nil-paid rights are worth $1.92 per share.
In some cases, rights are not transferable. These are known as "non-renounceable rights." But in most cases, rights allow you to decide whether you want to take up the option to buy the shares or sell your rights to other investors or the underwriter. Rights that can be traded are called "renounceable rights," and after they have been traded, the rights are known as nil-paid rights.
If the share price on the open market were to decline to the point that it's cheaper to buy the shares than the nil-paid rights, the value of the nil-paid rights would become worthless, and the rights issue would likely fail.
Why Companies Do Nil-Paid Rights Offerings
Companies most commonly issue a rights offering to raise additional capital. A company may need extra capital to meet its current financial obligations. Troubled companies typically use rights issues to pay down debt, especially when they are unable to borrow more money.
However, not all companies that pursue rights offerings are in financial trouble. Even companies with clean balance sheets may use rights issues to raise extra capital to fund expenditures designed to expand the company's business, such as acquisitions or opening new facilities for manufacturing or sales. If the company is using the extra capital to fund expansion, it can eventually lead to increased capital gains for shareholders despite the dilution of the outstanding shares as a result of the rights offering.