Stock rights definition
/What are Stock Rights?
Stock rights give their owner the right, but not the obligation, to buy the shares of a company at a specific exercise price for a designated period of time. The term primarily applies to giving current shareholders the right to buy additional shares as part of the issuer's next stock sale. The intent is to give existing shareholders the ability to maintain their current proportion of ownership in the business by acquiring the same proportion of the new issuance. This is a particular concern in closely-held organizations, where some shareholders want to maintain their control over the entity.
Stock Rights Example
A company decides to issue new shares to raise capital for expansion. The company offers rights to its existing shareholders under the following terms:
Each shareholder receives 1 right for every share they already own.
10 rights are required to purchase 1 new share.
The subscription price for the new share is set at $20 per share, whereas the current market price of the stock is $30 per share.
John owns 100 shares of the company. He receives 100 rights. With the 10:1 ratio, he can use his 100 rights to buy up to 10 new shares at the discounted price of $20 per share. He can buy 10 shares at $20 per share, for a total cost of $200. Since the market price is $300, he will realize an immediate gain of $100. John has the following options for how to use his stock rights:
Exercise the rights. He uses his rights to buy the discounted shares and enjoys the benefit of owning more shares at a lower cost.
Sell the rights. If the rights are transferable, he can sell them on the market (at a price determined by the difference between the market price and the subscription price).
Do nothing. If he doesn’t act, his rights will expire, and he may experience a dilution of his ownership percentage as others buy the new shares.
This example illustrates how stock rights work and the potential decisions available to shareholders.
Stock Rights Best Practices
Stock rights may be issued at an exercise price somewhat below the current market price, with no commission charge. By doing so, the issuer makes the shares more enticing to investors. This is also an advantage for the issuer, since it retains its existing shareholders through several rounds of stock issuances, rather than having to deal with new investors.