What is a rights issue?
When a company needs to raise a large amount of money quickly, it often goes to the people who already own it. A rights issue gives existing shareholders the chance to buy new shares at a discounted price — before the offer is made more widely. If you hold a stock in the Challenge and a rights issue is announced, the share price will almost certainly fall. This is why.
Why would a company issue more shares?
Companies need capital for all sorts of reasons. A retailer might want to buy a rival chain. An airline might need to pay down a mountain of debt taken on during a difficult year. A bank under regulatory pressure may need to strengthen its balance sheet. Borrowing from a lender is one option, but it comes with interest and conditions. Issuing new shares is another route: the company gets real cash in exchange, and in return it hands a portion of its future ownership to whoever buys the new shares.
Existing shareholders are offered first because they already bear the risk of owning the business. If the money raised makes the company more valuable, they deserve the first chance to protect — or increase — their stake. It also helps the company: a rights issue underwritten by loyal shareholders is easier to complete than a cold sale to strangers.
Rights issues have appeared in some of the biggest corporate moments in recent memory. The major UK banks used them heavily in 2008 and 2009 to stay solvent during the financial crisis. Many FTSE 100 and FTSE 250 companies reached for the same tool in 2020. Understanding how one works is not just a textbook exercise — it is a practical skill for anyone following a real portfolio, and you will encounter them in the Challenge.
How a rights issue works
The basics — a worked example
A company announces a “1 for 4 at 200p” rights issue. In plain English: for every 4 shares you already hold, you are entitled to buy 1 new share at 200p. If the ordinary shares are currently trading at 250p on the stock market, that is a 20% discount. The discount is deliberate — it makes the offer attractive enough that shareholders are likely to take part rather than ignore it. The window to decide typically runs for two to four weeks.
The company is not printing money. It is selling a portion of itself. Every new share sold represents a small dilution of everyone else’s slice — unless they buy their own allocation too. The market capitalisation of the company rises by the amount of cash raised, which is why the maths works out in the way you will see below.
Your three choices
Once a rights issue is announced, each existing shareholder faces the same three options:
| Choice | What you do | What it costs | Result for your stake |
|---|---|---|---|
| Take up your rights | Buy the new shares at the subscription price | 200p per new share | Your percentage in the company stays the same — no dilution |
| Sell your nil-paid rights | Sell the entitlement on the market without buying the shares | Nothing upfront | You receive cash; your existing shares are still diluted |
| Let your rights lapse | Do nothing | Nothing | Your percentage stake in the company shrinks |
The middle option — selling nil-paid rights — is worth a moment of attention. Once a rights issue is announced, the entitlements themselves are traded on the stock exchange separately from the ordinary shares. They are called “nil-paid rights” because no money has yet changed hands for the underlying shares. They have real monetary value: they give the buyer the right to purchase shares at a below-market price, and that discount has a price. If you cannot afford to exercise your allocation, or simply choose not to, you can sell the rights to someone who wants them rather than letting them expire worthless.
What happens to the share price?
The TERP (Theoretical Ex-Rights Price)
The day the rights issue goes ex-rights — meaning new buyers of the ordinary shares no longer receive the entitlement — the share price is expected to fall. This is not a sign that anything has gone wrong. It is pure arithmetic.
Here is how it works, using our example:
- You hold 4 shares at 250p each — total value: 1,000p
- You buy 1 new share at the subscription price of 200p — cost: 200p
- You now hold 5 shares with a combined value of 1,200p
- 1,200p ÷ 5 shares = 240p per share — the TERP
The TERP, or Theoretical Ex-Rights Price, is the expected new price once old and new shares are blended together. It reflects the fact that there are now more slices of the same pie, so each slice is worth a little less individually. The company has not become less valuable overall — it has just grown the number of shares outstanding.
If you held 4 shares before and you took up your rights, you now hold 5 shares at 240p: still 1,200p of total value, the same as before the offer. The dilution of the per-share price is offset by the extra share you now own. In this sense, exercising your rights protects you. It also protects your earnings per share from shrinking quite as fast, because your share count rises in proportion with the new total.
Why shares sometimes fall further than TERP
The maths explains the mechanical drop. The market’s mood explains everything on top of it.
If investors believe the money is being raised for a sensible, value-creating reason — funding an acquisition at a fair price, building a new factory in a growing market — the reaction can be muted or even positive. If they suspect the company is in serious trouble, plugging losses, or avoiding a covenant breach, the price can fall well below TERP as shareholders decide they would rather sell than throw good money after bad.
The size of the discount also sends a signal. A very large discount (say, 40% or 50% below the market price) often suggests management was worried that shareholders would not participate at a modest one — which is itself a warning sign. A smaller discount typically signals confidence that the offer will be well-received.
The question to ask whenever you see a rights issue announced is always the same: why does the company need the money? The answer is what the market is pricing, not the fact of the issue itself.
Rights issues in the Student Investor Challenge
In a real brokerage account, you would receive a formal notice explaining how many nil-paid rights you are entitled to, and you would choose from the three options above. The virtual portfolio cannot replicate the mechanics of physically exercising rights, but you can still make an informed decision: hold through the announcement, or sell beforehand.
Knowing TERP makes that decision clearer. A portion of the share price fall around the announcement date is automatic — it is maths, not disaster. The question is whether the drop beyond TERP reflects a genuine change in how the market values the underlying business. If the market is saying the reason for raising money is bad news, the shares may keep falling after the ex-rights date. If the reason looks sound, the price often stabilises near TERP.
Understanding the difference between a mechanical dilution drop and a sentiment-driven sell-off is exactly the kind of market literacy the Challenge is designed to build.
Rights issues at a glance — quick reference
| Term | Plain English |
|---|---|
| Rights issue | An offer to existing shareholders to buy new shares at a discount before the wider market |
| Subscription price | The discounted price at which the new shares are offered |
| TERP | The expected new share price once old and new shares are blended together |
| Nil-paid rights | The tradeable entitlement to buy new shares — before you have paid for them |
| Dilution | The shrinking of your percentage stake as new shares are added to the total |
Rights issues are a routine part of corporate life on the London Stock Exchange. They raise billions of pounds every year for acquisitions, expansions and, occasionally, rescue operations. You can read more about the regulatory framework on the London Stock Exchange’s official guidance for companies raising equity. Once you understand the mechanics — the discount, the TERP, the three choices — you can read any rights issue announcement and work out what it means for a shareholder. That is the whole point: the jargon looks intimidating until you peel it back, and then it is just arithmetic and a question about motive. The effect on the dividend per share is worth checking too, since more shares outstanding can dilute the income stream if the total payout stays flat.
FAQ
Is a rights issue good news or bad news?
It depends on why. A rights issue to fund a promising acquisition can be a positive signal. One that rescues a cash-strapped company from its debts is often negative. The market prices the reason in quickly — that is why shares can fall sharply when a rights issue is announced, even if the arithmetic of TERP only explains part of the drop.
What are nil-paid rights?
Nil-paid rights are the entitlement to buy new shares, stripped from the original shares and traded separately on the market during the offer period. They have real monetary value — even if you do not want the new shares yourself, you can sell the rights to someone who does, rather than letting them expire and receiving nothing.
What is dilution in a rights issue?
Dilution means your percentage stake in the company shrinks when new shares are issued. If you owned 100 shares out of one million and the company issues another 250,000 new shares, you now own 100 out of 1.25 million — a smaller slice of the same company. Taking up your rights (buying your allocated new shares) keeps your percentage the same.
What happens to the dividend when new shares are issued?
If a company keeps its total dividend payment the same but now has more shares to pay it across, the dividend per share falls. This is one reason income-focused investors sometimes sell when a rights issue is announced, even if they believe in the company’s long-term prospects.
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