Question

9. Woolworths Limited is a publicly listed corporation. Its core business is in supermarkets. Woolworths has decided to set up a major hardware goods chain in competition with the Wesfarmers Limited-owned Bunnings stores. Woolworths needs to raise additional equity capital to fund the expansion. The company advisors recommend the board of directors choose between a pro-rata rights issue and a private placement. Explain each of these funding alternatives and discuss the advantages and disadvantages of each alternative.

Answer 1

A rights issue is when fresh additional equity stock is offered to existing equity shareholders. The fresh equity shares are issued only to existing shareholders, who can either choose to subscribe to the shares, or choose to pass, or in some cases, choose to sell or transfer the right to others for or without a consideration

Advantages of a rights issue are :

• It is less cumbersome than an FPO or IPO in terms of regulatory hurdles and paperwork
• The stakes of existing shareholders are not diluted
• The decision to make a rights issue can be made by the board of directors, without need for shareholder approval

Disadvantages of a rights issue are :

• Shareholders who do not subscribe to the issue will see their stakes diluted
• There are usually regulatory limits as to the amount of equity that be raised with a rights issue

A private placement is when shares are issued to a private investor, or a group of private investors, rather than to the general public. These private investors are usually institutional investors.

Advantages of a private placement are :

• Regulation relating to a public issue can be avoided
• Public disclosure of financial statements is not required
• Investors can be chosen who align with the company's interests

Disadvantages of a private placement are :

• Shares may have to issued at a discount because price discovery is not possible