Preferential issue and rights issue are some of the ways equities are introduced for sale in the primary market. From the primary markets, the investors can decide whether they want to sell off in the stock exchange or hold for further capital appreciation.
What is preferential issue
Under Section 81 of the Companies Act, 1956, a preferential issue is an offering of shares or convertible securities by a listed company to a chosen group of people that is neither a rights issue nor a public issue. This is a more efficient method of raising equity capital for a business.
The issuer corporation must follow the Companies Act and the requirements in Chapter related to preferential allotment. This is as per the SEBI (DIP) rules, which include, among other things, pricing, disclosures in notice, and so on.
What is rights issue
Existing shareholders are invited to purchase additional new shares in the company through a rights issue. The shareholder can use the rights to buy new shares at a discount to the market price at a specified future period. The corporation is offering shareholders a discounted opportunity to enhance their exposure to the shares.
Also Read: 4 Reasons Why Companies Go For Rights Issue
Here are 6 major differences between preferential issue and rights issue
The major difference between the preferential issue and rights issue is the allowable participation of stakeholders to procure the said issue.
Only a selected group of investors get access to participate in preferential issues.
These stakeholders are the active participants in the day to day management of the business. This allows the promoters or venture investors to increase their share in their own business.
On the other hand, the stakeholders who have invested in the company through a secondary market can participate in the rights issue. For instance, a retail investor, domestic institutions or foreign institutions who have a share in the business, but does not participate in the active decision making process.
Stakeholder involvement in company’s business
The decision making stakeholders of the company get access to invest in preferential issues.
Although, the management also has the right to allot preferential issue to the investors they value and would like to onboard.
While, the secondary investors who do not participate in the active decision making in the business get access to invest in rights issue. They are passive investors who invest in the business based on value.
Intent of the issue
The major intent of both the issues is to raise capital for the business. Thus, the preferential issues allow the defined set of investors to increase their stake in the company by pumping in their own capital.
This allows the promoters and other valuable investors to invest in their own business without the involvement of secondary investors.
While, rights issues allow secondary investors to increase their stake in the business. This also gives an opportunity to reward the business
Limit for participation
As preferential issues are only available to a small group of investors, it is clear that these issues will be allocated to those investors in a predetermined ratio.
On the other hand, secondary investors have a limit to participate in the rights issue. Thus, these investors can buy rights issues only on a ratio that is proportional to the already investment made by the investors.
For example, rights issue of 1:15 implies that, an investor can be awarded with one share as rights issue if he has already invested in 15 shares of the company. Thus, considering the same example, if an investor needs to buy 100 shares from the rights issue, he needs to own 1500 shares of the company.
Emergency of raising funds
During the allotment of preferential issues, the promoters have no choice but to pump in their personal capital. This allows the company for some cushion to safe guard from the impact of losses.
Existing investors receive right issues to not only raise capital in a short period of time, but also to avoid dilution of shares with new investors.
Effect on the shareholder pattern
Preferential issues allow promoters to increase their stake in the business. For instance, when the company is expecting a good quarter, the promoters want to take the maximum benefit. These benefits can be capitalized in the form of dividends. And also, provide base capital from the promoters personal capital to recover the losses or run the business.
Preferential issues increases the promoters and other valuable investors stake in the business. This can be a positive indication for the company’s growth. This is because, the promoters are actively investing to provide growth to the company.
Rights issues allows the stakeholders to increase their stake in the company. This can be a way to reward their old and loyal investors of the secondary markets.
As the rights issue are always available at a discount. Thus, the equity holders can safely make a premium gain of 20 – 30%. This by either buying the rights issue or by selling their rights to other investor.
The major difference between preferential issues and rights issue is the access of participation from the investors. The primary goal in both the scenario is to raise capital for funding the business.