Subscription rights: Overview, definition, and example
What are subscription rights?
Subscription rights, also known as "preemptive rights" or "rights offering," give existing shareholders the opportunity to purchase additional shares in a company before the shares are offered to the public. These rights are typically issued by a company when it needs to raise additional capital through the sale of new stock. Shareholders are given the option to buy the new shares in proportion to their existing holdings, allowing them to maintain their ownership percentage and avoid dilution of their shares. Subscription rights can be transferable or non-transferable, depending on the terms set by the company.
For example, if a company decides to issue additional shares, it might grant subscription rights to existing shareholders, allowing them to purchase the new shares at a discounted price before the shares are made available to others.
Why are subscription rights important?
Subscription rights are important because they protect existing shareholders from dilution. Without these rights, shareholders’ ownership percentages could be reduced when a company issues new shares. By offering subscription rights, a company ensures that its current shareholders have the chance to maintain their proportionate ownership in the company, should they choose to exercise their rights. Additionally, subscription rights can be an attractive feature for investors, offering them the chance to buy new shares at a discount.
For companies, subscription rights provide a way to raise capital while keeping the current shareholder base intact. This method can also help avoid the potential negative market reaction that might occur if the company simply issued new shares to the public without offering existing shareholders the opportunity to participate first.
Understanding subscription rights through an example
Imagine a company, ABC Corp., has 1 million shares outstanding, and it needs to raise capital to fund a new project. The company decides to issue 200,000 additional shares. To prevent diluting the existing shareholders’ ownership, ABC Corp. grants subscription rights to its shareholders. Each existing shareholder receives the right to purchase additional shares at a discounted price of $8 per share, whereas the market price is $10 per share.
If a shareholder owns 100 shares, they would be entitled to purchase an additional 20 shares (based on the proportion of shares they already hold) at the discounted price. The shareholder can choose to exercise their subscription rights, purchase the new shares, or let the rights expire.
In another example, a company may issue subscription rights to raise funds for an acquisition. Shareholders can use the rights to buy new shares at a reduced price, helping the company raise the capital it needs while allowing shareholders to maintain their stake.
An example of a "subscription rights" clause
Here’s how a subscription rights clause might appear in a shareholder agreement or offering document:
“The Company hereby grants to each shareholder of record as of the Record Date the right to subscribe for additional shares of common stock, at a subscription price of $[insert price] per share, in proportion to their current holdings. Each shareholder will be entitled to purchase additional shares in the amount of [insert number of shares] per [insert number of shares owned]. The subscription rights will be exercisable from [insert date] to [insert date], after which the rights will expire.”
Conclusion
Subscription rights are a way for companies to raise capital while giving existing shareholders the opportunity to maintain their ownership percentage. These rights allow shareholders to purchase additional shares at a discounted price before the shares are made available to the public, thus protecting them from dilution. For businesses, offering subscription rights can help raise funds while maintaining shareholder loyalty. For shareholders, subscription rights provide a chance to increase their stake in the company, often at a favorable price.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.