Most companies often need to raise additional capital from time to time, either by borrowing money or through selling new shares.

Rights issues are one fairly common way companies raise money by selling new shares.

In September this year, I&M Bank Rwanda had a Rights Issue presenting existing shareholders the opportunity to increase their stake in the Bank by buying 1 new share for every 5 ordinary shares they hold at a discounted price of Rwf 39.60.

From the rights issue, the bank raised close to Rwf8 Billion with a  total of 202,000,000 new shares issued.

Below we look at the basic factors of a rights issue.

What is a rights issue?

In essence, when a company taps into the existing shareholders for additional capital and issues shares at a discount particularly for these existing shareholders, the process is called rights issue shares.

Ordinarily, the idea is to get the additional capital from the existing shareholders without trying any external methods.

Why do companies make this move?

According to Investopedia, when a company is planning an expansion of its operations, it may require a huge amount of capital.

Instead of opting for a debt however, the company chooses to go for equity to avoid fixed payments of interest. To raise equity capital, a rights issue is largely described as a faster way to achieve this development.

Similarly, companies seeking to improve their debt-to-equity ratio or even looking to buy a new company may opt for funding through the rights issue method.

In rare situations, experts argue that the same method is commonly used for troubled companies looking to pay off debt in order to improve their financial status.

Simple mathematics to explain a rights issue

If an investor owns 100 shares in a certain company and the shares are trading at Rwf20,000 each. The company announces a rights issue in the ratio of one share for every five currently held shares, that means that each investor holding five shares will be allowed to buy a new share.

The company also announces a discounted price of for instance, Rwf5000 per share. It means that for every five shares (each at Rwf20,000), held by an existing shareholder, the company will offer one share at a discounted price of Rwf5,000.

Investors portfolio value (before rights issue) = 100 shares x Rwf20,000 = Rwf2 million

Number of right shares to be received = 100 x 1/5 = 20 shares.

Total price to buy rights shares = 20 shares x Rwf5,000 = Rwf100,000.

Total number of shares after exercising rights issue = 100 shares + 20 shares = 120 shares

Revised value of the investor’s portfolio after exercising the rights issue = Rwf2 million + Rwf100,000 = Rwf2.1 million.

Mathematically, this means that price per share post-rights issue = Rwf2.1 million / 120 shares = Rwf17,500.

Reports indicate that, much as the price of Rwf17,500 is theoretically correct, markets behave differently. While an uptrend in the share price will benefit the investor, a dip in the price will lead to losses.

In the present Covid-19 struck economy, experts argue that companies are in dire need of funds to support the financial stress.

Needless to say, in such times of a recovering economy, promoters infuse funds or raise capital for the company.

One of the ways that has gained popular preference is through offering Rights Issues.