Here's the deal:

  • A rights offering provides a company's stockholders an opportunity to subscribe for additional shares, based on the number of shares they own as of a set record date.
  • Rights offerings typically remain open for a set period, which is usually a couple weeks.
  • A rights offering does not require stockholder approval, provided that the rights offering is not a "standby" rights offering, wherein the standby purchaser receives special rights or preferences.
  • A majority of rights offerings involve non-transferable rights, although an issuer can also elect to structure an offering to permit rights to be transferable.
  • Trading of the transferable rights can take place either on the securities exchange where the issuer's common stock is listed or over the counter, if the common stock is not listed on a securities exchange.

Introduction

In the midst of the economic downturn driven by the COVID-19 pandemic, companies facing liquidity issues may consider a rights offering. This guide provides an overview of rights offerings.

What's the Deal?

A rights offering typically provides an issuer's existing shareholders the opportunity to purchase a pro rata portion of additional shares (also referred to as "subscription warrants") of the issuer's stock at a specific price per share (the "subscription price"), which may be set at a discount to the recent trading price of the issuer's stock.

In a rights offering, all shareholders are given the right to purchase shares based on the number of shares they own on a specified record date, so there is no dilutive effect to shareholders who exercise the rights issued to them. Because there is no dilutive effect, stock exchange rules generally do not require issuers to obtain shareholder approval for issuances that may involve 20% or more of the outstanding shares at a discount to current market value.

Typically, a rights offering will be open for a period of a couple weeks. There are no federal securities laws requiring the rights offering to be open for a specified period of time.

Types of Rights Offerings

STANDBY RIGHTS OFFERING

In a standby rights offering, a third party (usually an underwriting syndicate, an investment bank, an affiliate of the investment bank or an affiliate of the issuer that may not be a registered broker-dealer) agrees, prior to the commencement of the rights offering, to purchase any shares or rights that are not subscribed for in the rights offering. This arrangement is commonly known as a "standby commitment," and provides the issuer with some assurance that it will raise the necessary capital. If the rights offering is structured as a standby rights offering, the issuer will enter into an agreement with the party agreeing to provide the standby commitment. An issuer may also consider a standby rights offering if the issuer's stock price is volatile. This is because the offering period is usually at least 16 days but can extend up to 60 days. Most shareholders will wait until the end of the subscription period to decide whether to exercise their rights. If the shares are trading in the market for the same or less than the subscription price, then shareholders will not exercise their rights. The issuer has to consider where to set its subscription price to avoid this, while not selling the shares at too steep of a discount price. Entering into a standby commitment may help mitigate this issue.

  • Fees associated with a standby commitment: As compensation for shifting the risk from the issuer if there is an under-subscription, the standby commitment party is paid a flat standby fee, plus a per share amount for each unsubscribed share purchased by it after the subscription offer expires and for each share purchased by it on the exercise of rights purchased in the secondary market, if the rights are transferable.
  • Requirements for standby commitment parties: There is no broker-dealer licensing requirement for standby commitment parties, although most are investment banks or an underwriting syndicate formed by an investment bank. However, one or more substantial investors will sometimes agree to act as a standby commitment party.

DIRECT RIGHTS OFFERING

In a direct rights offering, there is no standby commitment party, or standby purchaser. Instead, the issuer only sells the number of shares evidenced by the exercised rights. A direct rights offering is cheaper than a standby rights offering because there are no fees associated with providing the standby commitment. However, a poorly subscribed direct rights offering may leave an issuer under-capitalized.

Preparation and Considerations in Connection with a Rights Offering

A rights offering requires advance planning and preparation. The issuer must take a number of actions within a certain time frame, including, but not limited to, the following: providing information to shareholders; marketing the rights offering to shareholders; collecting exercise certificates and payment from shareholders; and filing documentation with the SEC and the applicable stock exchange.

More specifically, the issuer must determine if it has sufficient authorized and unissued shares to accommodate the number of shares that could be issued in connection with the rights offering. If not, the necessary corporate actions must be taken to authorize new shares. The issuer's board of directors will be required to: (1) authorize the rights offering; (2) set the record date to determine the shareholders of record entitled to participate in the rights offering; (3) set an offer date; and (4) set an expiration date for the offer period.

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Originally published June 4, 2020.

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