What is a rights issue? A guide for UK investors

This guide explains how rights issues work, the mechanics behind them and the choices available to you as a UK investor. The aim is to provide clarity on a process that can seem complicated at first glance.

Rights issue definition

A rights issue is a method companies use to raise capital by offering existing shareholders the right to purchase new shares in proportion to their current holdings. The key word here is ‘right’ rather than ‘obligation’. You are not compelled to participate.

The new shares are usually offered at a discount to the prevailing market price. This discount is often intended to help offset the dilution effect that occurs when additional shares enter circulation, though outcomes depend on market movements and the issue terms. Think of it as a company returning to its existing owners first, rather than seeking new investors elsewhere.

Rights issues differ from other share-raising methods such as placings or open offers. In a placing, shares might be offered to institutional investors without giving retail shareholders first refusal. A rights issue preserves your proportional ownership if you choose to participate fully.

How a rights issue works

When a company announces a rights issue, it specifies several key details: the number of new shares being issued, the subscription price and the ratio at which existing shareholders can participate. The announcement also includes important dates for accepting or trading the rights.

The subscription ratio explained

The subscription ratio tells you how many new shares you can buy relative to your existing holding. A 1-for-4 ratio means you can purchase one new share for every four shares you currently own. If you hold 400 shares, you would have the right to buy 100 additional shares.

Common subscription ratios include:

The ratio a company chooses reflects how much capital it needs relative to its existing share count. A more aggressive ratio such as 1-for-2 indicates a larger capital raising exercise.

Understanding the theoretical ex-rights price (TERP)

The theoretical ex-rights price is a calculation that estimates what the share price might be after the rights issue completes. It blends the current market price with the discounted subscription price, weighted by the respective number of shares.

The formula works as follows:

TERP = (Value of existing shares + Value of new shares) ÷ Total shares after issue

For instance, suppose a company’s shares trade at 500p and it announces a 1-for-4 rights issue at 400p. For every five shares in total after the issue (four original plus one new), the theoretical value would be:

TERP = (4 × 500p + 1 × 400p) ÷ 5 = 2400p ÷ 5 = 480p

This theoretical ex-rights price of 480p is lower than the original 500p because the cheaper new shares dilute the average. However, the TERP is theoretical. Actual post-issue prices depend on market conditions, investor sentiment and how the company plans to use the funds raised.

What are your options as a shareholder?

When a rights issue is announced, you face three choices. Each has different implications for your investment and your proportional stake in the company.

Take up your rights

You can exercise your rights in full by paying the subscription price for all the new shares you are entitled to. This maintains your percentage ownership in the company. If you held 1% of the company before, you would still hold approximately 1% afterwards.

This option requires additional capital. You need to consider whether you have the funds available and whether concentrating more money in a single investment aligns with your broader financial situation.

Sell your rights (nil-paid dealing)

If you do not wish to invest more money but want to capture some value from your rights, you can sell them. The rights themselves have a market value during the nil-paid dealing period, which typically lasts two to three weeks.

The nil-paid rights trade separately from the ordinary shares. Their value roughly reflects the difference between the current share price and the subscription price, adjusted for the dilution effect. Selling your rights means accepting dilution of your proportional ownership but receiving cash compensation.

Let your rights lapse

If you take no action, your rights will lapse at the end of the acceptance period. Many companies have mechanisms to sell lapsed rights in the market and return any proceeds (less costs) to inactive shareholders. However, this is not guaranteed, and the amount received may be minimal or nothing.

Letting rights lapse means your ownership percentage decreases without receiving full compensation. This passive approach is often less favourable because you may be diluted without receiving proceeds, though circumstances vary.

Why companies launch rights issues

Companies launch rights issues for various reasons. Understanding the stated purpose can help you assess whether the capital raising aligns with the company’s long-term prospects.

Common reasons include:

• Reducing debt on the balance sheet

• Funding acquisitions or expansion plans

• Strengthening capital reserves during difficult trading periods

• Meeting regulatory capital requirements (particularly relevant for banks)

• Financing research, development or major projects

The market’s reaction to a rights issue often depends on why the money is being raised. Funding a strategic acquisition might be viewed positively. Raising capital to shore up a weakened balance sheet might signal underlying problems.

Potential advantages and disadvantages for shareholders

Rights issues present both potential benefits and drawbacks. Your view will depend on your assessment of the company and your personal financial position.

The discount offered in a rights issue is not a guaranteed profit. If the company’s share price declines after the issue, you could find yourself holding shares worth less than you paid, even accounting for the discount.

Key considerations before deciding

Before responding to a rights issue, several factors warrant careful thought. Your decision should reflect your individual circumstances, and what suits one investor may not suit another.

Consider the following questions:

• Why is the company raising capital, and do you support its stated plans?

• What is your current level of exposure to this company relative to your overall portfolio?

• Do you have the available funds without disrupting other financial commitments?

• How has the company performed recently, and what is your view of its prospects?

• What are the tax implications of your chosen action?

If you hold shares within an ISA or SIPP, check with your provider about the process for taking up rights within the wrapper. Administrative procedures and deadlines may differ.

The decision is yours to make based on your own situation. This article is for information only and does not provide personal investment or tax advice. If you are uncertain, seeking guidance from a regulated financial adviser may help you think through the implications.

Summary

A rights issue offers existing shareholders the opportunity to purchase additional shares at a discount in proportion to their current holdings. The process involves understanding the subscription ratio and considering the theoretical ex-rights price to gauge potential dilution effects.

You have three options when a rights issue is announced: take up your rights and invest more, sell your rights through nil-paid dealing or let them lapse. Each choice has different consequences for your ownership stake and wallet.

Companies use rights issues to raise capital for purposes ranging from debt reduction to funding growth. The appropriateness of participating depends on your assessment of the company’s plans, your financial capacity and your existing portfolio composition.

Rights issues are neither inherently good nor bad. They are a capital-raising mechanism that requires shareholders to make an active decision within a defined timeframe. Understanding the mechanics ensures you can respond thoughtfully rather than reactively.