What is Rights Entitlement in Stock? Meaning, How to Buy, Benefits

Investing through the stock market typically involves learning about various funds or sources of capital by which business organisations hope to attract further investment. Rights entitlement allows existing shareholders to buy additional shares at a lower price. This article explains what rights entitlement means, how to buy rights entitlement as an investor, the benefits and risks involved, and its effect on share prices.

What is Rights Entitlement?

As a privilege offered by a publicly listed company to its existing shareholders, a rights entitlement (RE) allows purchasing additional shares at a price lower than the current market value as a right by paying an amount known as the subscription price.

The main purposes of issuing rights entitlements to the shareholders could include the following:

• First, further investment by the existing shareholders at a lesser cost.
• Secondly, it is a means for raising funds without resorting to external borrowing or public issuance of shares.

Rights Entitlement in Stocks: How Does it Work?

The company makes the following important decisions concerning rights entitlement:

• Subscription Price: The discounted price at which shareholders can purchase shares.
• Ratio in Rights Entitlement: The ratio represents the proportion of rights shares offered in relation to existing shares. For example, in a 1:2 rights issue, holding two shares grants the right to purchase one additional share.
• Exercising Period: The stipulated period given to the shareholder to exercise his right to purchase additional shares.
• Tradability: If a shareholder decides not to purchase additional shares, some rights entitlements can be sold in the open market before they expire.

How to Buy Rights Entitlement Shares

If you hold shares of a company issuing rights entitlements, your broker or depository will notify you. Here’s how you can purchase them:

1. Receive the Notification: Once a company announces a rights entitlement issue, shareholders receive a notice detailing the subscription price, ratio, and deadline.
2. Check Your Eligibility: Investors who hold the company’s shares on the record date are eligible for rights entitlements.
3. Decide on Exercising or Selling: You must choose whether to buy the additional shares, sell your entitlements, or let them lapse.
4. Fill Out the Application Form: If you wish to buy shares, submit the rights application form via your broker or depository participant.
5. Make the Payment: Pay the subscription price before the deadline.
6. Receive the Shares: The new shares are credited to your demat account once the payment is processed.

It is important to note that rights and entitlements have a deadline, usually a few weeks, beyond which they expire if not exercised.

Understanding the Mechanics of Rights Entitlement

Rights entitlements follow a structured process:

• Announcement of the Rights Issue: The company publicly announces the offer, including the number of shares, subscription price, and eligibility criteria.
• Trading of Rights Entitlements: In some cases, rights entitlements are tradable securities, meaning shareholders can sell them in the stock market.
• Exercising the Rights: Shareholders who wish to buy shares at the discounted price must exercise their rights before the deadline.
• Issuance of Additional Shares: The company issues additional shares to participating investors once the exercise period ends.
• Expiry of Unused Rights: Any unexercised rights entitlements become void after the closing date.

Benefits of Rights Entitlements

Rights entitlements provide several advantages for both shareholders and companies:

• Purchase Shares at a Discount: Investors can acquire new shares at a price lower than the current market rate, which can be financially beneficial if the stock price rises.
• Increase Shareholding Without Additional Brokerage Costs: Buying additional shares through rights issues can help investors increase their stake in the company without paying brokerage fees or other transaction costs associated with open-market purchases.
• No Obligation to Purchase: Shareholders are not compelled to buy additional shares. They can sell their entitlements in the market or let them expire.
• Fundraising for Company Growth: Rights issues help companies raise capital for expansion, debt reduction, or new projects without issuing new shares to external investors.

Impact of Rights Entitlement on Stock Price

When a company issues rights entitlements, it influences the stock price in different ways:

• Dilution Effect: Since new shares are introduced into the market, the total number of outstanding shares increases, which can cause a drop in stock price due to dilution.
• Market Reaction to Fund Utilisation: If the capital raised is used for growth-oriented projects, the stock price may increase over time, offsetting the dilution effect. The stock price may decline if investors perceive that the company is issuing new shares to cover financial distress.
• Short-Term Price Adjustments: After a rights issue, stock prices may fluctuate based on investor sentiment, market demand, and the perceived value of the company’s expansion plans.

Risks Associated with Rights Entitlements

While rights entitlements present an opportunity, they also involve certain risks:

1. Stock Price Drop Below Subscription Price: If market conditions worsen, the stock price could fall below the subscription price before the rights issue closes, making the offer less attractive.
2. Dilution of Share Value: If a shareholder does not exercise their rights, their ownership percentage decreases, potentially affecting their voting power in the company.
3. Limited Trading Window: Rights entitlements come with a short exercise period. If shareholders do not act within the timeframe, they lose the opportunity to buy discounted shares.
4. Tax and Brokerage Costs: When sold in the market, some rights entitlements may be subject to capital gains tax or brokerage fees.

Conclusion

Rights entitlement is an effective tool for companies to raise capital while rewarding existing shareholders with discounted share purchases. For investors, it offers an opportunity to strengthen their stake in a company at a lower cost. However, careful evaluation is needed before considering factors such as potential stock dilution, market conditions, and the company’s financial health.

Investors should analyse whether participating in a rights issue aligns with their investment goals. Consulting a financial advisor can help ensure these investment decisions align with personal financial objectives.

Understanding how rights entitlements work enables investors to make informed choices that optimise their portfolio strategy while supporting the growth of their companies.