Equity Shares: Bonus Issue vs Rights Issue

Share price

It’s easy to mixup subjects within a topic when studying CIMA and I’ve found myself making silly mistakes when it comes to mock exams for the F2 subject. One particular area I found myself tripping up on was the difference between a rights issues and bonus issues of shares.

Here is a run down on the difference between the two.

Bonus Issue of Shares

A bonus issue of shares (also known as a script issue) is quite simply an issue of ordinary shares to existing shareholders at no additional cost.

This usually happens when a company has a surplus amount of reserves and they want to capitalise it into share capital. If a company is announcing it making a Bonus Issue of shares it usually means they are sitting on a large amount of funds.

No additional funds are raised by the company if they decide to make a bonus issue. However, the share price will be affected by the number of bonus shares issued. For example;

  •  Company X has 50,000 shares in issue at £10 per share
  • Which equates to a total for £500,000 in ordinary share capital
  • At the end of the year, Company X decides to offer a bonus issue on a 1 for 5 basis
  • Now the total number of shares in issue is 60,000
  • This gives a new share price of £8.33 (£500,000/60,000)

Why issue bonus shares?

It might seem a pointless exercise to issue shares for “free” but in fact it can serve a very useful performance. Firstly, it rewards current investors and encourages them to purchase more shares on the basis the company is performing well.

It might also be used to stimulate growth and generate extra investment, as the share price will drop this will encourage investors who may have been put off the higher share price while it also improves liquidity in the company by increasing the number of shares in issue without any extra cost to the company.

Rights Issue of Shares

A rights issue of shares is also to existing shareholders (the only common trait it has with a bonus issue), however, a rights issue will cost the existing shareholder money to purchase the shares – albeit at a lower price.

In this case, the rights issue is offered at a discounted price to the shareholder and is a way of raising additional capital into the business. So unlike a bonus issue, the purpose of a rights issue is to RAISE additional funds and it in fact could be seen as a sign the business is struggling due to the fact it’s looking to raise finance at a discounted price.

Here is a example of a rights issue and how it would affect the existing shareholders:

  • Company Y had £750,000 in share capital (100,000 shares@£7.50 each)
  • They offer a Rights Issue on a 1 for 4 basis at £5 each
  • All shareholders take up the option for rights issue
  • Company Y now has £875,000 in share capital (125,000 shares@£7 each)

You can see the share price has dropped to £7 per share with the rights issue but the company has raised an additional £125,000 in the process, so, in theory, if they put the investment to good use they will see their share price in the future.

ONE IMPORTANT POINT TO NOTE:

  • A rights issue will have a negative impact on the existing shareholders who DO NOT take up the option of purchasing the additional shares through a rights issue.
  • For example;
  • Company ABC has in issue 1000 ordinary shares (10 shareholders have 100 shares)
  • The company offers a rights issue for 1 in 4 basis but only 9 shareholders take up the option.
  • This means there is now 1225 shares in issue: (9×25)+1000 = 1225
  • So the shareholder who didn’t take up the option only now owns 8.2% of the company, where previously they owned 10%.

 

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