What Are Share Purchase Rights?
A share repurchase right in a financial contract gives the right holder the option, but not the obligation, to purchase (or repurchase) a predetermined number of shares at a predetermined price. This is similar to a stock option or warrant on a stock. These rights are typically distributed to existing shareholders, who have the ability to trade these rights on an exchange.
- A share repurchase right gives the holder the option to buy a predetermined number of shares at a set price.
- The rights are typically offered to existing shareholders to boost management performance and the stock price.
- Share purchase rights are not the same as a share purchase plan or stock buyback where stocks are bought back from the open market.
Stock Rights Issue
Understanding Share Purchase Rights
Share purchase rights only give shareholders the ability to purchase the shares, but they must still pay for the shares to redeem the rights.
Similar to a preemptive right, a share repurchase right may carry a certain amount of weight with investors who don't want their equity investment in an entity diluted by the expansion of a business's equity base. Investors owning a series of share repurchase rights effectively have a call option to reconsolidate their proportional stake in a business. This can be important for investors desiring a control position.
Why Offer Share Purchase Rights?
Share repurchase rights are usually tied to an equity valuation incentive program. For instance, to motivate central or founding management teams, a certain number of common shares that have been distributed to external shareholders might be packaged as part of a repurchase plan. Here, a company's founding management team might be incentivized to outperform so they can repurchase (or clawback) equity shares sold during a financing round.
If a company has significant debt, it may issue out share purchase rights and use the funds to pay part of the debt.
In the case of startups, profits are slow to realize, and it can be difficult to obtain funding from banks. Companies can issue out share purchase rights to generate the funding they need.
Share Purchase Right vs. Share Purchase Plan
Although similar in name, a share repurchase right should not be confused with a share repurchase plan or what is often simply called stock buybacks. A share repurchase plan is a dedicated program a corporation uses to buy back its own shares in the open market. This usually happens when a company feels its shares are undervalued in the market.
More recently, these programs have come under fire for potentially engineering excessive executive compensation schemes.
Example of Share Purchase Right Application
Company XYZ is a startup with a new product. The company offers its stakeholders purchasing rights for shares in the product to raise needed financing. The shareholders who use their rights to buy additional shares profit when the product goes to market and is successful and the share price goes up. However, if the product goes to market and fails, the shareholder incurs losses.
Before exercising share purchase rights, investors should research the company's potential and understand the implications of not exercising share purchase rights in terms of dilution of control.