What is Rights Entitlement?

Key Takeaways

• Rights entitlement allows existing shareholders to buy additional shares at a discount, with the option to trade, exercise, or let the entitlement expire.
• Companies issue rights entitlement when they want to raise additional capital for the current shareholders.
• The shares are issued at a discounted price to attract shareholders to apply and are automatically credited to their demat accounts.
   

Capital is one of the most fundamental factors in a business's operations. If a company wants to hire new employees, it must have additional capital to pay their salaries. Similarly, if it wants to start a new factory to manufacture more products to meet demand and increase sales, it must have enough capital for infrastructure expenses. Private companies can look towards private investors such as venture capitalists to raise money and have enough capital. However, public companies with listed shares on stock exchanges, such as NSE and BSE, have the option to raise additional capital for their current shareholders. The shareholders also benefit as they receive additional shares at a discounted price, increasing their profit potential.

Why rights entitlement?

A rights entitlement (RE) is a temporary security issued to existing shareholders by companies who want to raise additional capital. The shares issued to existing shareholders are part of the rights issue announced by the company and require the shareholders to either apply, sell, or let the shares expire. If the shareholders apply for the shares under rights entitlement, they must pay the amount at which the company has issued the shares. The shares are generally issued at a discounted price, which is lower than the current trading price of the stocks. Hence, right entitlement represents the shareholder's right to buy additional shares at a discounted price before the offer is made to the general public.

The additional shares are issued to the shareholders based on their existing holdings. For example, if a company announces a 1:5 rights issue, shareholders receive one additional share for every five shares they own.

Read more: What is a Demat account

How rights entitlement work?

When a company wants to raise additional funds, it can either do so through a Follow-on Public Offer (FPO) or through rights entitlement. Rights entitlements give the current shareholders an option to buy additional company shares at a discounted price. Once a company announces a rights entitlement, the temporary shares are automatically credited to the demat accounts of eligible shareholders on the record date. The record date is the cut-off date to determine eligible shareholders.

Once the shareholders receive the shares in their demat accounts, they can either apply for or sell them in the secondary market. Shareholders can trade rights entitlement shares on the stock exchange like regular shares during a specific window and make profits by selling them to other investors. If shareholders want to apply for the shares, they are required to pay for them before the rights issue window closes. The rights entitlement lapses if they choose not to exercise their additional shares or sell them.
 

Read more: How to open a Demat account
 

How rights entitlement affects your investments?

Here is how the right entitlement affects your investments once announced by the companies:

• Additional shares: If you apply to a rights entitlement, the number of shares in your portfolio increases. You can sell the shares easily in the secondary market.
• Portfolio allocation: If you apply for the rights entitlement shares, your portfolio’s allocation to the particular stock will increase.
• Dilution: If you do not exercise the rights entitlement, your ownership percentage in the company may decrease as new shares are issued and they increase the number of outstanding shares.
• Market impact: The share price may fall as it adjusts to the new shares issued by the company. This can negatively impact your investment value even if you do not exercise the rights entitlement.
   

Read more: What is dematerialisation

Key benefits of rights entitlement

Here are the key benefits of rights entitlement

• Discounted shares: Companies issue rights entitlement shares at a discount from the current market price. It helps shareholders get additional shares at a lower price.
• No dilution: By exercising rights entitlement, shareholders can maintain their proportional ownership in the company, preventing dilution of voting power and equity.
• Extra profits: Rights entitlement allows shareholders to sell the temporary shares to other investors if they don’t want to exercise the rights issue, providing them extra profits.
• Flexibility: The shareholders have the flexibility to exercise the issue and buy additional shares, sell the entitlement, or do nothing and let them lapse.
   

Read more: Difference between demat and trading account
 

Steps to exercise your rights entitlement

If you have received rights entitlement, follow the below process to exercise them:

• Step 1: Log in to your demat account to see the credit or rights entitlement shares. Review the rights issue terms, including the issue price, ratio, and the last date for application.
• Step 2: Click on the rights issue shares to see an ‘Apply’ option. Enter details such as the number of shares you want to buy and click on ‘Apply.’
• Step 3: Complete the payment for the shares using your bank account linked to the demat account. You can do this through net banking, UPI, or ASBA (Application Supported by Blocked Amount).
   

Conclusion

Rights entitlement is a process used by companies to raise additional funds by issuing additional shares to the current shareholders at discounted prices. Under rights entitlement, the shareholders have the option to either sell the shares, exercise them, or let them lapse. The shareholders benefit from rights entitlement as they can make extra profits by selling them or getting additional shares of the company if they exercise the right. Now that you know what rights entitlement is, you can make an informed decision on whether to sell, apply, or let them expire.