Rights offerings are an alternative method for public companies to raise capital from existing stockholders. In a rights offering, the issuer grants a right to each of its existing stockholders for no consideration. The right, which is usually nontransferable, entitles the stockholder to subscribe for a share of common stock at a set price, typically at a discount from the trading price for the issuer’s shares. The shares underlying the purchase rights must be registered using Form S-1 or Form S-3 for the company to comply with securities laws and for the stockholders to be able to freely sell the shares.
A rights offering can be an attractive alternative when the market for a company’s shares is particularly volatile and the company’s stockholders are sensitive to dilution. With the addition of a backstop commitment or standby purchaser, the company can have more certainty about the amount of capital being raised. A standby purchaser is an existing stockholder or third party that agrees to purchase any shares not subscribed for by the stockholders in the rights offering. Companies undertaking a rights offering do not have to engage an investment bank to serve as a placement agent or underwriter but may choose to do so or use the investment bank as a standby purchaser.
- Limited dilution to existing stockholders – All stockholders have the opportunity to maintain their ownership in the company without the potential dilution of a traditional offering.
- Less time commitment from management team – The rights offering is made to existing stockholders; management time and energy are not devoted to the roadshow.
- Set subscription price – Once the subscription price is set, the price is not subject to changes in the trading price for the company’s common stock.
- No prior stockholder approval – Rights offerings are not subject to the NYSE or Nasdaq rules requiring stockholder approval for non-public offerings resulting in an issuance of 20% or more of the issuer’s outstanding common stock.
- Limited transaction expenses – If no investment bank is engaged to help facilitate the offering, the issuer is able to utilize more of the capital raised.
- No guaranteed amount of capital to be raised – Stockholders must subscribe for shares for funds to be raised unless using a backstop commitment or standby purchaser.
- Less attractive pricing – Set subscription price is typically at a discount to the trading price and must be attractive enough from the stockholders’ perspective to motivate their investment.
- Potential concentration of ownership – If only a few large stockholders subscribe for shares, ownership can become concentrated in those large stockholders, potentially limiting the voting power of others.
- Must comply with “Baby Shelf” rules – Issuers with a non-affiliate market cap of less than $75 million must limit the size of all offerings over a rolling 12-month period to one-third of their current public float. This ceiling may make this option less appealing for small-cap or micro-cap issuers.
- Longer offering period – Because of the built-in open window for stockholders to subscribe for shares, a rights offering takes longer than a takedown offering, and if using Form S-1 to register the shares, can take as long as a traditional IPO depending on the level of SEC review and the company’s preparedness.
Before structuring a rights offering, a company should consider:
- Support of existing stockholders
- A rights offering is a good option for an issuer with a stockholder base that is committed to management’s vision and willing to inject more capital in the company.
- A rights offering would be a more challenging option for a company with many stockholders that are disengaged from the company’s progress.
- Baby Shelf rules
- Issuers subject to the “Baby Shelf” rules are not permitted to sell more than one-third of their non-affiliate market cap during any trailing 12-month period.
- This capacity is re-measured before any potential shelf offering and can fluctuate based on the market price of the issuer’s shares and the issuer’s affiliates’ holdings.
- NSYE or Nasdaq requirements
- Although rights offerings are not subject to the 20% rule, exchanges still have notice requirements for listing additional shares.
- Failure to meet the notice requirements in a timely fashion can slow down the progress of the offering.