Raising Funds with Rights Issue: A Right Strategy for Listed Companies during Covid-19 Era
Executive Overview & Context
“Opportunities don’t happen. You create them.” As the saying goes, we know that due to unprecedented Covid-19 pandemic, several companies are struggling to raise finance and listed companies are not an exception. However, SEBI has pro-actively taken various measures to rationalise the process besides offering various relaxations for rights issues which can help listed companies to quickly raise funds to meet their requirements. Already dozens of large listed companies have taken benefits under this special scheme and their rights issues have got great response from the shareholders. Being an expert in financial domain CAs have a critical role to play by offering comprehensive solutions to listed companies by harnessing the opportunities and providing necessary support. Read on to know more…
Background & Regulatory Framework
Rights issue is a primary market offer in which all existing shareholders get an opportunity to acquire additional shares in the company on a pro-rata basis. Every shareholder can use his own discretion while choosing an option to buy shares and may decide to acquire entire or part of the eligible stake while renouncing balance to others. Though there is no compulsion on any shareholder to subscribe for shares as per his entitlement, often companies offer good discount over prevailing market price and so, usually majority of the shareholders opt for exercising their rights.
Any company can raise funds by launching rights issue after complying with the provisions under the Companies Act, 2013, however, if the company is listed on recognised stock exchanges then applicable provisions under multiple SEBI regulations also need to be complied with:
- SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code)
- SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations)
- SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations)
- SEBI (Buy-back of Securities) Regulations, 2018
Types of Rights Issues
Rights issue can be of different types and the company may choose any one or combination of them to suit their requirements while offering an option to all its shareholders:
- Fully Paid Rights Issue
- Partly Paid Rights Issue
- Renounceable Rights Issue
- Non-Renounceable Rights Issue
- Fast Track Rights Issue
- Normal Rights Issue > ₹ 50 Cr
- Normal Rights Issue < ₹ 50 Cr
Key Process Outline & Basis of Allotment
The companies can opt for ‘Fast-Track Rights Issue’ of more than ₹ 50 crores if the conditions laid down in Regulation 99 of SEBI ICDR Regulations are met and in such cases, SEBI has offered multiple relaxations. Otherwise, the following standard process has to be followed by the company for the rights issue:
- Obtaining approval from the Board of Directors
- Appointment of various intermediaries for the issue including lead manager, registrar, banker, legal advisors, advertisement / PR agency, statutory auditors, etc. Underwriter need not be appointed as underwriting is not compulsory.
- Carrying out due diligence review and legal documentation besides determining offer price
- Obtaining in-principle approval from the regulator / stock exchanges
- Fixation of record date in consultation with the lead manager
- Sending abridged letter of offer and application forms
- Obtaining ASBA facility through bankers
- Crediting Right Entitlements (REs) in demat accounts through depositories
- Opening of Issue: Period remains open for 15 to 30 days
- Allotment of shares and refund of balance proceeds
Sequential Hierarchy for Allotment of Equity Shares:
- Shareholders to the extent of their entitlement;
- Renouncees to the extent of their entitlement;
- If shares are still available, then one share to those eligible shareholders having fractional entitlement and who applied for at least 1 additional share;
- If shares are still available, then to those eligible shareholders who applied for additional shares in proportion to their holding as on the record date;
- If shares are still available, then to eligible Renouncees who applied for additional shares;
- If anything is left even after aforesaid allotment, then it would be treated as unsubscribed portion of the issue. It is generally distributed among the shareholders and renouncees who have applied for any additional shares.
Pricing Mechanism & Theoretical Ex-Rights Price (TERP)
The companies have been given complete freedom to determine pricing for the rights issue as per their choice, however, usually significant discount is offered over the prevailing market price in order to reward loyal shareholders and make offer attractive. Given the regulatory approvals required for issuing of shares below face value, traditionally offer price has been at the face value or higher.
Due to discounted price of rights issue, the price of shares gets diluted. Hence, it is likely to go down with the increase in total number of shares after issue. Share price after issue can be estimated mathematically and is called as “Theoretical Ex-Rights Price” (TERP).
Practical Illustration:
XYZ Company announces rights issue of 1:2 (i.e. 1 share for every 2 shares held) at a concessional offer price of ₹ 70 while the current market price is ₹ 100.
- TERP = [(100 × 2) + (70 × 1)] / 3 = 270 / 3 = ₹ 90
- Value of Right = 90 – 70 = ₹ 20
The shares of XYZ company may trade at ₹ 90 ex-rights and value of Right will be ₹ 20. However, this is an estimate based on mathematical calculations; actual market price may substantially differ based on market sentiments and prospects.
Right Entitlements (REs) & Shareholder Options
Rights Entitlements (REs) are the standard rights issued by the company to all its existing shareholders for subscribing to new shares. REs are offered to shareholders on pro-rata basis in proportion with their existing equity shares held as on the record date. If any shareholder is holding shares in physical form then he will have to provide details of his demat account for getting REs.
REs are issued in dematerialised form and have separate ISIN, however, they can be traded in online as well as offline mode. Separate scrip code is issued by stock exchanges for trading of REs and while its opening price is decided by the exchanges, subsequently it is determined by the market dynamics. Anybody can purchase REs and also apply for the rights issue in the given proportion during the issue period. However, if no application is made by the purchaser of REs on or before closing date of issue then such REs will lapse. Once trading in REs stop then it cannot be extended again even if there is an extension of rights issue.
Eligible shareholders can exercise any of the following 6 options during the rights issue:
- Apply for their rights fully as per their REs
- Apply for their rights fully as per their REs and also apply for excess rights shares
- Apply for their rights partly as per their REs and renounce balance REs
- Apply for their rights partly as per their REs but don’t renounce balance REs
- Renounce their REs fully
- Neither apply for rights shares nor renounce REs (REs will lapse)
Strategic Advantages of Rights Issues
Advantages to Companies:
- Very rare chance of failure
- Fastest mode of raising capital without incurring any extra debt
- Economical option: saves underwriting, advertising, and roadshow costs
- Motivation to existing shareholders via discounted pricing
- Preferred mode over preferential allotment due to relaxation in lock-in requirements
Advantages to Shareholders:
- Retain proportionate voting rights and control
- Lucrative option to accumulate shares below market price
- Facility for physical holders to participate by submitting demat details
- Use of seamless R-WAP platform for resident individuals and HUF investors
Promoter Creeping Acquisition & Trading Window Benefits:
- Exemption Beyond 5% Creeping Limit: Under the SEBI Takeover Code, promoters can ordinarily acquire up to 5% per FY. Through rights issues, promoters can acquire even beyond 5% without triggering a mandatory Open Offer under Regulation 3(2), provided the issue price is less than the ex-rights price.
- Trading Window Relaxation: As per SEBI circular dated 23-07-2020, REs can be bought or sold by promoters even during the Trading Window closure period.
Special Relaxations by SEBI during Covid-19 Era
Due to the ongoing Covid-19 pandemic, there is an unprecedented economic crisis resulting into huge scarcity of funds. Every company has to compulsorily wait for at least 1 year after completion of buyback process as per Regulation 24 of SEBI Buyback Regulations, 2018 if it wishes to raise further capital. However, SEBI temporarily reduced this timeline from 1 year to 6 months to give relief to corporates facing acute liquidity crunches.
Further, SEBI issued various circulars after March 2020 to rationalise the process and offer major relaxations:
- Higher Threshold for Draft Filing: Filing of Letter of Offer to SEBI is not required for rights issues up to ₹ 50 crores (raised from earlier threshold of ₹ 10 crores).
- Minimum Subscription Relaxation: Waiver of compulsory 90% minimum subscription criteria, subject to prescribed conditions.
- Fast-Track Rights Issue Eligibility: Conditional relaxation to companies in case of pending show-cause notices, provided full disclosure of potential adverse impact is made.
- Truncated Disclosures: Financial statements restricted to last 1 year instead of the customary 3 years.
Examples of Mega Rights Issues Successfully Mobilised:
Key Role of Chartered Accountants
In our nation of more than 135 crore Indians, hardly 5,000 companies are listed on nationwide stock exchanges, but their cumulative market valuation exceeds USD 2 Trillion. Under the Companies Act, 2013, financial statements of every company must be audited by a practising Chartered Accountant. Beyond audit, CAs provide premium advisory in accounts, taxation, corporate finance, restructuring, capital markets, risk management, and compliance.
While large conglomerates have in-house teams, mid-sized and small listed companies urgently need expert guidance to navigate SEBI relaxations. Chartered Accountants can bank upon their expertise and strong network across the entire lifecycle:
- Analysing requirement of funds and its quantification
- Devising suitable funding structure and issue type
- Appointment of intermediaries for the issue and legal documentation
- Determining size of issue and offer price
- Assisting the company for successful due diligence review
- Meeting requirements of regulators and complying with different regulations
- Co-ordinating with different agencies and bankers for timely receipt of issue proceeds
- Co-ordinating with stock exchanges and depositories for post-issue formalities
Given the very high quantum of penalties for non-compliances under different securities regulations, working with maximum precaution is essential. Chartered Accountants can certainly play a pivotal role in tapping this immense advisory opportunity.