A rights issue is when a listed company offers existing shareholders the right to buy additional shares at a discounted price, in proportion to their existing holdings. Unlike a public offering, only current shareholders get this opportunity. But the decision — subscribe, sell your rights, or do nothing — has significant financial consequences that many retail investors don't understand.
How a Rights Issue Works
The company announces a rights issue specifying:
- Ratio: e.g., 1:4 means 1 new share for every 4 held (25% expansion)
- Issue price: Always at a discount to the current market price — typically 10–40% below CMP
- Record date: Shareholders on record on this date are eligible
- Issue open/close dates: Period during which you must apply or sell your Rights Entitlements (REs)
Rights Issue Example
You hold 400 shares of XYZ Ltd trading at ₹500. Rights issue announced: 1:4 at ₹350/share.
Your entitlement: 400 ÷ 4 = 100 new shares at ₹350 each.
Cost to subscribe: 100 × ₹350 = ₹35,000
After subscription: you hold 500 shares.
Theoretical Ex-Rights Price (TERP)
After a rights issue, the stock price adjusts. The TERP estimates the fair post-issue price:
TERP = (Existing shares × CMP + New shares × Issue Price) ÷ Total shares post-issue
Using the example above: (400 × ₹500 + 100 × ₹350) ÷ 500 = (₹2,00,000 + ₹35,000) ÷ 500 = ₹470/share
So the stock should theoretically trade at ₹470 post-record-date (down from ₹500). The ₹30 drop per share is compensated by the ₹150 discount on the 100 new shares — net position is neutral if you subscribe.
Rights Entitlements (REs): The Tradeable Right
SEBI mandated from 2020 that Rights Entitlements (REs) must be credited to demat accounts and listed on stock exchanges for trading. This means:
- If you don't want to subscribe, you can sell your REs on the exchange during the issue period and receive cash
- If you want more than your entitlement, you can buy additional REs from the market and apply for more shares
- This makes the Indian rights issue system much more investor-friendly than the old "subscribe or lose" model
Three Choices for Shareholders
| Choice | Action | Financial Impact |
|---|
| Subscribe fully | Apply for all entitled shares; pay the issue price | Average cost of holding reduces; maintain % ownership; good if you believe in the company |
| Sell Rights Entitlements | Sell REs on exchange during issue period | Receive cash for the discount value; don't invest more but compensate for stock price dilution |
| Do nothing (lapse) | Neither subscribe nor sell REs | Worst choice — REs lapse worthless; your holding is diluted; you receive nothing for the discount value |
⚠ Never let Rights Entitlements lapse. If you choose not to subscribe, at least sell your REs on the exchange. Allowing them to lapse means your existing shareholding gets diluted AND you get no compensation — pure value destruction.
Tax Treatment of Rights Issues
- Subscribing to new shares: No tax event at the time of subscription. The new shares' cost of acquisition = issue price paid. Holding period starts from allotment date.
- Selling Rights Entitlements (REs): The sale proceeds from selling REs on the exchange are taxable as capital gains. Cost of acquisition of REs = ₹0 (they were received free). So 100% of the RE sale proceeds are taxable — as STCG if sold within 12 months, LTCG if held longer (unlikely, given the issue period is typically 15–30 days).
- Bonus shares received in rights context: Same as regular bonus shares — see our bonus shares guide.
How to Apply for a Rights Issue
- Log in to your broker's trading platform or the ASBA (Application Supported by Blocked Amount) portal
- Go to IPO/Rights Issue section; find the rights issue of the relevant company
- Apply for up to your entitlement (and optionally for additional shares beyond entitlement)
- Funds are blocked in your bank account via ASBA until allotment; debited only on successful allotment
- Alternatively, use the R-WAP (Registrar's Web-based Application Platform) if you hold shares in physical form
Why Companies Do Rights Issues
Companies raise capital via rights issues for: debt repayment (deleveraging), funding capex for expansion, working capital requirements, or acquisitions. A rights issue is generally viewed as less dilutive than a QIP (Qualified Institutional Placement) because existing shareholders get first right to maintain their percentage. However, a rights issue at a very large discount or for a company in financial stress can signal trouble — always read the "objects of the issue" in the letter of offer carefully.
Frequently Asked Questions
If I sell my Rights Entitlements, is my shareholding diluted? ▼
Yes — by selling your REs (rather than subscribing), you are choosing not to participate in the expansion of the company's share capital. New shares will be issued to those who subscribe (and to buyers of your REs who then subscribe). Your existing shareholding as a percentage of total shares outstanding will decrease. The RE sale proceeds compensate you for this dilution in cash terms (at the theoretical value of the discount), but you no longer benefit from any future upside on those shares. Think of it as effectively selling a small part of your stake at a discounted value.
Can I apply for more shares than my entitlement in a rights issue? ▼
Yes. In most rights issues, shareholders can apply for additional shares beyond their entitlement in the application form. These additional shares are allotted only if there are unsubscribed shares available after all entitled shareholders have been allotted. Additional allotment is typically done on a proportionate basis among all those who applied for additional shares. There is no guarantee of additional allotment, but it's worth applying if you want to increase your position at the discounted price.
How is the Rights Entitlement (RE) value calculated? ▼
The theoretical value of an RE (what you can sell it for on the exchange) is approximately: RE Value = TERP − Issue Price. In our example: ₹470 (TERP) − ₹350 (issue price) = ₹120 per RE. So each RE you sell should theoretically yield approximately ₹120. In practice, RE prices on the exchange fluctuate based on the underlying stock price movement during the issue period. The actual RE trading price may differ from the theoretical value depending on supply/demand and stock price movements during the rights issue period.