Non-Renounceable Rights
The option to purchase additional shares of the company, usually at a price lower than the market price
What are Non-Renounceable Rights?
Non-renounceable rights are issued by the company offering the shareholders the option to purchase additional shares of the company, usually at a price lower than the market price. The rights can neither be transferred to other investors nor sold in the market. Non-renounceable rights lapse if not exercised.
Non-renounceable rights are often issued when new shares of the company are offered in the market. Hence, the rights allow the shareholders to compensate for the dilution of their holdings by purchasing new shares at a discounted price. The non-renounceable rights compensate the shareholders equivalently for the cost of the dilution of their shares.
When shares are issued, the value of existing shares is diluted. Therefore, if the shareholders do not exercise the rights and buy discounted shares, their shares will undergo dilution, and they will lose money.
Summary
- Non-renounceable rights offered by the company give a right to the shareholders to buy extra shares at a discount.
- Non-renounceable rights are not transferrable; hence, the shareholders cannot trade the rights in the market.
- The shareholders can take advantage of the non-renounceable rights offering and compensate for the effect of dilution of shares by buying new shares on discount.
How a Non-Renounceable Rights Offering Works
A company may issue non-renounceable rights when it is unable to secure funds through loans or from angel investors or venture capitalists. The shareholders are informed by the company about the issuance of the rights, which allows them to buy extra shares at specific – but discounted – prices. The company also specifies the deadline for buying the discounted shares, beyond which the rights would lapse.
If the company offers non-renounceable rights, the shareholders are not given the option to sell the rights. Hence, the shareholders will decide whether to exercise the right or do nothing at all. The shareholders evaluate their decision depending on the number of shares that they would be able to buy, the discount offered on those shares, and the financial health of the company.
However, if the shareholders decide not to buy extra shares, then their holdings in the company will be diluted even though new shares are issued – the proportion of their shares remain unchanged.
Benefits of Non-Renounceable Rights
- Existing shareholders effectively get the shares on sale. Assuming that the company’s stock value will increase in the future, a rights issue can prove to be profitable. It also depends on the number of shares that they can buy through the rights offered. Usually, the shareholders can buy shares in proportion to the amount that they currently own.
- Companies issue the rights to fulfill their capital needs. When a company is struggling financially, offering non-renounceable rights can eliminate debt obligations and help improve the company’s balance sheet.
- When the existing shareholders exercise the non-renounceable rights, an increase in the number of outstanding shares in the market can attract more investors, resulting in a rise in the share price.
Drawbacks of Non-Renounceable Rights
- When shareholders buy stocks, their holdings in the company get diluted. Although they get additional shares at a discount, the percentage of the stocks owned decreases as a result of an increase in the number of outstanding shares.
- A company with a financial need to maintain its expectation of going concern can issue non-renounceable rights without considering the share dilution effect on current shareholders.
- Non-renounceable rights can be a less suitable option for shareholders, as it does not allow them to sell the rights on the market to earn returns for themselves.
- The offering of non-renounceable rights can be perceived as an anxious step by the company to obtain funds. It can raise speculation in the market regarding the financial health of the company. Consequently, the company’s stock price may lose value, and shareholders can lose money.
Generally, rights offerings are stimulated by the financial requirements of the company, and the rights may provide a chance for the shareholders to broaden their investment portfolio. However, the shareholders should consider the benefits and drawbacks to determine their impact on their investment goals. Exercising non-renounceable rights may backfire if buying additional stocks on discount does not fit into their investment strategy.
Additional Resources
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:
