What is a Rights Offering?

A rights offering is a notification by a company to its shareholders, giving them the right to buy more shares. The amount of additional shares that shareholders are able to purchase is in proportion to their existing share holdings. Each of these rights has a termination date, which is usually within one month. Other features that may be added to a rights offering are:

Shares can be purchased at a discount to the market price
The rights can be transferred to a third party, so that they can be sold on the open market

A rights offering is usually issued by a closely-held company. In this situation, shareholders are more likely to want to maintain their existing proportion of total shares outstanding, in order to maintain their ownership percentage in the business. However, there is no obligation for them to do so. If they do not take advantage of a rights offering, then their ownership share of the business will decline.

Characteristics of a Rights Offering

The key characteristics of a rights offering are as follows:

Preemptive rights. Existing shareholders are given the first right to buy additional shares before they are offered to the public, allowing them to maintain their proportional ownership in the company.
Proportional allocation. Shareholders are typically allowed to buy additional shares in proportion to their current holdings. For instance, if a shareholder owns 5% of the company, they can purchase 5% of the new shares being issued.
Limited time frame. The rights are only valid for a specific period, often a few weeks. Shareholders must decide whether to exercise their rights within this timeframe.
Tradability. In many cases, the rights can be traded on the stock exchange (referred to as "transferable rights"). Shareholders who do not wish to exercise their rights can sell them to other investors.
Dilution protection. A rights offering minimizes the dilution of existing shareholders’ ownership because they have the opportunity to purchase additional shares to maintain their percentage stake.
Optional participation. Shareholders are not obligated to exercise their rights. They can let them expire or sell them, depending on their investment strategy.

When to Issue a Rights Offering

A rights offering can be expensive for the issuer, since equity is the most expensive form of funding. Consequently, a rights offering is more likely to be issued when it is not possible to acquire any additional debt. This situation arises when a lender demands that a business obtain more equity before it will consent to the issuance of any additional debt.