What is The Difference Between a Rights and a Bonus Issue?

Once in a while we keep hearing about companies issuing rights and bonus issues. One should be aware of such terms while investing in equities as they tend to affect share prices. Here are few points which makes rights and bonus issue different.

Rights Issue:

A rights issue is the issue of additional or new shares for the existing shareholders of the company. The listed company raises additional capital via rights issue and shareholders can subscribe to the newly issued shares in proportion of their current holdings.

The purpose of the rights issue is primarily to raise fresh capital for corporate expansion or a takeover. This practice is also resorted to by a company to prevent any likelihood of being conked out.

Primarily, equity capital and market capitalization of the company gets affected with the rights issue. The issue of fresh equity raises equity capital of the company while change in market capitalization is as perceived by the market. Also, rights issue gives the company better leveraging opportunities.

If shareholder does not subscribe then percentage of his shareholding comes down after the issue. Also, he or she can sell the right as the rights are generally tradable or they can simply ignore and let the rights issue lapse.

For example, a company declares rights issue of 3: 5 at Rs 100 per share. Current share price is at Rs 150 per share, means the company is issuing three rights shares for every five shares held by the shareholders of the company at Rs. 100 per share.

If shareholder does not subscribe, than percentage of his shareholding comes down after the issue.

Advantages of Issuing Rights

1) As it is issued to existing shareholder, there is less chances of losing control over shareholders.
2) Company need not spend money on advertisement and other new issue cost.

Disadvantage

The share value gets diluted with increase in number of shares issued. Investors may get tempted to buy as it is offered at a discount. But one needs to understand why the company is in need of funds. While, for company also it is temporary fix and it will impact on the balance sheet of the company.

Disadvantage of rights issue

The right should be only exercised in a case, when the shareholder is completely sure about the company's performance. Further, in case, if the share price has fallen well below the subscription price for the rights issue, shareholder must not take up the rights.

Bonus Shares:

These shares are unlike rights share, they are issued for free to the shareholders of the company. Bonus issues are generally issued by profit making companies by captalizing the free reserves. Additional shares are distributed based on the number of stock held by the shareholder. While, it increases the stocks owned, it does not increases the total value.

For example, a company declares bonus issue of 1:4, it means that it is issuing one bonus share for every four shares held by the shareholders of the company.

To issue bonus the company has to fulfill some conditions. Here is what they to need to satisfy:

1) Bonus issue should be authorized by Articles of Association.
2) Shareholders must sanction in the general meeting on recommendation of Board of the company.
3) SEBI guidelines should be complied.
4) In case of loan from financial institutions, company should obtain their permission.
5) Stock exchanges should be intimated.

So, the most important difference in both the issue is, if the company announces rights issue than it means it is in need of funding. Company announcing bonus means it is sitting on pile of money. In both cases it raises the outstanding shares of the company, while increasing the volatility in share prices. The other big difference is that in the case of rights you need to pay for it, while in the case of bonus it is free.

Conclusion:

These days we do not find many companies issuing rights shares to shareholders. Just like initial public offerings, this is one area that is not seeing capital being raised. Bonus issues are also rare, and most companies prefer the route of splitting the face value of their shares.

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