Question

In: Finance

Companies can raise new equity funding through a number of ways. A rights issue offers existing...

Companies can raise new equity funding through a number of ways. A rights issue offers existing shareholders the opportunity to purchase additional shares at a discounted price, based on the number of shares an investor already holds. A private share placement is a share issue offered to specific investor groups rather than the public.

  1. What are the benefits and costs/ disadvantages for a listed firm looking to raise equity capital through a rights issue?                                                                                                       
  2. Compared to a rights issue, what are the arguments for and against a private share placement as a means to raise equity capital?                                                                                   

Solutions

Expert Solution

a. A listed firm could be benefited through rights issue in the following ways :

  • Lesser underwriting costs
  • Lesser regulatory requirements as compared to IPO or FPO
  • Faster turnaround time as compared to IPO or FPO

However, rights issue is an option given to the existing shareholders to purchase shares of the company. It is possible that shareholders may not subscribe to sufficient number of shares to meet the company's funding requirements. Shares are issued at a discount, since the option is given to the existing shareholders. This could lead to dilution and decrease in EPS.

b. Advantages and dis-advantages of private placement in comparison to the rights issue

Advantages :

  • Generally instituitional investors and HNIs participate in private placements. Company goes through series of negotiations before concluding the private placement. Hence, to a great extent, company has the opportunity to understand and align both parties' objectives and requirements
  • Investments are done for a long-time horizon and also from a strategic objective in most cases
  • Participation of instituitional investors can boost confidence/sentiments of the general market - especially if investors are marquee names
  • As the amount of equity stake involved could be significant, private placements are generally done at premium in comparison to the ongoing market rates (however, this may not hold true if the company is having funding issues in general)
  • Lower transaction cost, quicker turn-around time

Dis-advantages :

  • Private placement would result in equity dilution of existing shareholders
  • Difficulty in finding suitable investors - marquee/anchor investors would have higher negotiating power in dictating terms of the deal
  • If the investment stake is significant and depending on the negotiating terms, investors may demand for representation in board (common in private equity investment)

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