Rights Offering (Issue)

A rights offering is a group of rights offered to existing shareholders to purchase additional stock shares, known as subscription warrants, in proportion to their existing holdings.  In a rights offering, the subscription price at which each share may be purchased is generally discounted relative to the current market price. Rights are often transferable, allowing the holder to sell them in the open market.

In a rights offering, each shareholder receives the right to purchase a pro rata allocation of additional shares at a specific price and within a specific period (usually 16 to 30 days). Shareholders are not obligated to exercise this right.  

There are two general types of rights offerings: direct rights offerings and insured/standby rights offerings.  In direct rights offerings, there are no standby/backstop purchasers (purchasers willing to purchase unexercised rights) as the issuer only sells the number of exercised shares.  If not subscribed properly, the issuer may be undercapitalized.  Insured/standby rights offerings, usually the more expensive type, allow third-parties/backstop purchasers (e.g. investment banks) to purchase unexercised rights.  The backstop purchasers agree to the purchase prior to the rights offering.  This type of agreement ensures the issuing company that their capital requirements will be met.  

Companies generally offer rights when they need to raise money. Examples include when there is a need to pay off debt, purchase equipment, or acquire another company. In some cases, a company may use a rights offering to raise money when there are no other viable financing alternatives.  Other significant benefits of a rights offering are that the issuing company can bypass underwriting fees, there is no shareholder approval needed, and market interest in the issuer's common stock generally peaks. For existing shareholders, rights offerings present the opportunity to purchase additional shares at a discount.

Sometimes, rights offerings present disadvantages to the issuing company and existing shareholders.  Shareholders may disapprove because of their concern with dilution.  The offering may result in more concentrated investor positions.  The issuing company, in an attempt to raise capital, may find that additional required filings and procedures associated with the rights offering are too costly and time-consuming; the costs of the rights offering may outweigh the benefits (cost-benefit principle).