# Understanding Rights Offerings: Definition, Types, Pros & Cons

![Rights Offering (Issue)](https://www.investopedia.com/thmb/wKdxTsVh1dHazrH5UhxO9VNhCuE=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/rightsoffering-Final-425cc283cba942e6b122a4b096093c7c.jpg)

*— Investopedia / Zoe Hansen*

## What Is a Rights Offering (Issue)?

A rights offering allows existing shareholders to buy additional stock shares at a discounted price. This financial option can be advantageous for companies seeking to raise capital without the need for shareholder approval, although it may dilute existing shares. Rights offerings are usually available for a limited time and can be bought or sold on the market, providing shareholders with flexibility and control over their investments.

### Key Takeaways

*   A rights offering allows existing shareholders to buy additional shares at a discount, proportionate to their current holdings.
*   Rights are often transferable, letting shareholders sell them on the open market before they exercise or expire.
*   There are two main types of rights offerings: direct rights offerings and insured/standby rights offerings, each with different risk profiles.
*   Companies use rights offerings to raise capital, bypassing underwriting fees and increasing shareholder interest in the stock.
*   While rights offerings provide capital, they may dilute existing shares' value and can have time-consuming and costly requirements.

#### Rights Offering

## Understanding the Mechanics of a Rights Offering

In a rights offering, each shareholder receives the right to purchase a pro-rata allocation of additional shares at a specific price and within a specific period (usually 16 to 30 days). [Shareholders](https://www.investopedia.com/terms/s/shareholder.asp), notably, are not obligated to exercise this right. 

A rights offering is effectively an invitation to existing shareholders to purchase additional new [shares](https://www.investopedia.com/terms/s/shares.asp) in the company. More specifically, this type of issue gives existing shareholders securities called "rights," which, well, give the shareholders the right to purchase new shares at a discount to the [market price](https://www.investopedia.com/terms/m/market-price.asp) on a stated future date. The company is giving shareholders a chance to increase their exposure to the stock at a discount price.

But until the date at which the new shares can be purchased, shareholders may trade the rights on the market the same way that they would trade [ordinary shares](https://www.investopedia.com/terms/o/ordinaryshares.asp). Rights issued to shareholders have value, which compensates them for future dilution of their existing shares' value. Dilution happens because a rights offering spreads a company's net profit over more shares. As a result, the company's earnings per share (EPS) decrease due to share dilution.

## Exploring Different Types of Rights Offerings

There are two general types of rights offerings: direct rights offerings and insured/standby rights offerings. 

*   In direct rights offerings, there are no [standby/backstop purchasers](https://www.investopedia.com/terms/b/backstop_purchaser.asp) (purchasers willing to purchase unexercised rights) as the issuer only sells the number of exercised shares. If not subscribed properly, the issuer may be undercapitalized. 
*   Insured/standby rights offerings, usually more costly, let third parties, like investment banks, buy unexercised rights. The backstop purchasers agree to the purchase prior to the rights offering. This agreement ensures the issuing company meets its capital requirements.

> **Important**
>
> In some cases, rights issued are not transferable. These are known as "non-renounceable rights." In other cases, the beneficiary of a rights issue may sell them to another party.

## Pros and Cons of Rights Offerings

### Advantages

Companies generally offer rights when they need to raise money. Examples include when there is a need to pay off debt, purchase equipment, or acquire another company. In some cases, a company may use a rights offering to raise money when there are no other viable financing alternatives.

Other significant benefits of a rights offering are that the issuing company can bypass [underwriting fees](https://www.investopedia.com/terms/u/underwriting-fees.asp), there is no shareholder approval needed, and market interest in the issuer's common stock generally peaks. For existing shareholders, rights offerings present the opportunity to purchase additional shares at a discount.

### Disadvantages

Rights offerings can sometimes disadvantage the issuing company and its shareholders. Shareholders may disapprove because of their concern with [dilution](https://www.investopedia.com/terms/d/dilution.asp). The offering may result in more concentrated investor positions.

The issuing company, in an attempt to raise capital, may find that additional required filings and procedures associated with the rights offering are too costly and time-consuming; the costs of the rights offering may outweigh the benefits [(cost-benefit principle)](https://www.investopedia.com/terms/c/cost-benefitanalysis.asp). 

## Why Would a Company Do a Rights Offering?

The main reason to do a rights offering is to raise capital. The capital can be used to expand the business or pay down existing debt, or any other need. Companies may issue rights offerings to existing shareholders as a benefit to shareholders as well as a way to avoid the time-consuming and costly process of underwriting and releasing more shares to the public.

## How Do Rights Offerings Affect a Company's Stock Price?

Rights offerings dilute the value of existing shares because more shares have been released through the rights offering. This can harm the stock price, as well as the fact that a rights offering can be associated with companies that are struggling financially, so investor confidence is diminished, reducing the stock price.

## Do I Have to Purchase Stock Through a Rights Offering?

Existing shareholders are not obligated to purchase additional stock through a rights offering; the offering simply offers them a chance to purchase more stock.

## The Bottom Line

Rights offerings provide existing shareholders the opportunity to acquire additional stock at a discounted price, offering them the option, but not the obligation, to purchase more shares. These offerings serve as a tool for companies to raise capital efficiently, bypassing underwriting fees and shareholder approval.

However, they often lead to share dilution, affecting stock value. For companies, rights offerings can be a strategic solution to raise funds for expansion or debt reduction, especially when other financing options are limited. Shareholders should weigh the benefits of discounted shares against potential dilution impacts.