Rights: A Cmo Investor's Guide

Rights in investing refer to the rights granted to shareholders in a corporation. Shareholders are considered owners of the company and have a say in how it is operated. They have the right to attend annual general meetings, vote on resolutions, propose their own resolutions, participate in appointing directors, and review financial reports, among other rights.

In addition, companies sometimes issue rights offerings or rights issues, which allow shareholders to buy additional shares at a discount or sell those rights to another investor. This is one way for companies to raise capital.

Shareholders' rights to buy additional shares at a discount

A rights issue is an invitation from a company to its existing shareholders to purchase additional shares in the company. This type of issue offers shareholders securities called rights. Rights issues are a way for companies to raise capital, often to pay down debt.

Shareholders may choose to subscribe to the rights issue in full, ignore the rights issue, or sell their rights to other investors. If they subscribe to the rights issue in full, they will need to spend a certain amount per share they are entitled to purchase. For example, if they hold 1,000 shares, they can buy up to 300 new shares at a discounted price of $3 each, for a total price of $900.

The discounted price is only offered for a direct purchase from the company. Once the offer period ends, shareholders must buy additional shares on the market if they want more, and the market price will not be the same as the discounted price.

Rights issues can be beneficial for companies as they are a lower-cost way of raising capital compared to a loan or a follow-on public offering (FPO). For shareholders, the benefit is the opportunity to purchase more shares at a discount. However, investors should be cautious and investigate the purpose of the additional funding, as a rights issue can be associated with companies that are struggling financially.

Rights and warrants vs options

Rights, warrants, and options are all financial instruments that companies can use to raise capital. They are similar in that they give the holder the right to buy or sell shares at a specific price and date. However, there are some key differences between them.

Rights

Rights are issued by companies to current shareholders to provide them with the opportunity to preserve their fraction of corporate ownership. Typically, a single right is issued for each share of stock, and each right can usually purchase a fraction of a share. Rights are short-term instruments that expire quickly, usually within 30-60 days of issuance. The exercise price of rights is always set below the current market price, and no commission is charged for their redemption.

Warrants

Warrants are long-term instruments that allow shareholders to purchase additional shares of stock at a discounted price. They are typically issued with an exercise price above the current market price. Warrants are usually valid for one to five years and are issued directly by the company. Warrants are often included as a "sweetener" for an equity or debt issue to make it more attractive to investors.

Options

Options are contracts between two people that give the holder the right, but not the obligation, to buy or sell a stock at a specific price, prior to a specific date. Options are typically traded between investors, and the underlying company is not involved. Options usually have expiration dates measured in days, weeks, or months, although Long-Term Equity Anticipation Securities (LEAPS) can last up to three years. Options do not involve the issuance of new shares, so they do not dilute existing shareholders' stakes in the business.

Rights and Warrants vs. Options

Rights and warrants differ from options in that they are initially issued only to existing shareholders, while options can be traded between investors. Rights and warrants also have shorter expiration dates than options, usually expiring within 30-60 days. Additionally, when a right or warrant is exercised, the company issues new shares to the holder, diluting the ownership of existing shareholders. In contrast, exercising an option involves the transfer of shares between two investors, with no impact on the percentage of the company owned by other shareholders.

Rights issues and how they work

Rights issues are a way for companies to raise capital by offering existing shareholders the opportunity to buy additional shares directly from the company at a discounted price. This is often done to raise money to pay down debt, fund acquisitions or expansions, or improve their debt-to-equity ratio.

Rights issues are typically undertaken when a company needs to raise a large amount of capital quickly. By issuing rights, companies can raise money without incurring underwriting fees, although some rights issuances are underwritten by investment banking firms to ensure the desired amount of capital is raised. Rights are usually distributed as dividends, with the number of additional shares that can be purchased proportional to shareholders' existing holdings. Shareholders are not obligated to purchase the additional shares, but if they choose not to, their existing shareholding will be diluted.

Shareholders who receive rights have several options: they can purchase the additional shares, ignore the rights issue, sell their rights to other investors, or do nothing and let their rights expire. The rights are typically valid for a specified time frame, after which the discounted price returns to normal.

Rights issues can be beneficial for companies as a lower-cost way of raising capital compared to loans or follow-on public offerings. For shareholders, the benefit is the opportunity to purchase more shares at a discount. However, there are also risks involved in rights issues. If the company is in financial trouble, investors may not want to buy additional shares, even at a discounted price. Additionally, the market may interpret a rights issue as a warning sign that a company is struggling, potentially causing a drop in share prices.

Rights of common shareholders

The exact rights of shareholders in a corporation depend on the type of stock they own and the state laws, which usually follow the Model Business Corporations Act. Here is a detailed list of the rights of common shareholders:

• The right to information – Shareholders have the right to investigate the company's administrative and financial records. While public companies have to make this information publicly available, private companies don't have to disclose any of it, neither to the public nor to the shareholders. To review financial statements or governing documents, shareholders of private entities need to request those documents specifically.
• The right to vote – During yearly meetings, shareholders can cast their votes to elect directors. They can choose to vote either for the director that the board of directors nominating committee proposes, or they could propose their own candidate. In the latter case, shareholders must provide justification for their choice and hand out their own proxy materials. The two standard voting methods are straight voting and cumulative voting.
• The right to influence fundamental changes in a corporation – Any cardinal changes require the shareholders' approval. For example, mergers, sales of assets, and dissolutions.
• The right to make changes in governing documentation – Shareholders can vote for any changes to the governing documents, such as the charter or the bylaws amendments.
• The right to hold meetings – All corporations must hold yearly shareholder meetings to vote and to discuss any necessary governance actions. Directors and large shareholders have the right to request special meetings for any type of issue.
• The right to make proposals – Shareholders with 1% of outstanding shares can suggest topics for corporate meeting discussions and voting. Except for regular business operations, shareholders can make proposals pertaining to any other aspects of the company, such as environmental or labor practices, political spending, and other topics.
• The right to dissent – Dissenter rights protect shareholders and allow them to sell their shares if they do not approve of the core corporate management or governance. This way, shareholders can make the corporation buy their shares back at a "fair value".
• The right to transfer ownership – Shareholders can trade their stock on the exchange market. This provides liquidity to the shareholders. They can sell their shares at any time and get cash in hand for another purpose. This investment benefit is not available in other investments like property.
• The right to dividends – Shareholders are entitled to profits in the form of dividends. The board of directors determines the percentage of profits to be paid out.
• The right to sue for wrongful acts – Executed in the form of shareholder class-action lawsuits, this right protects shareholders against poor management.

Investor rights and how they are protected

Investor rights are the rights granted to shareholders in a corporation. These rights include legal and financial protections, as well as certain privileges. They are generally governed by law and outlined in shareholder agreements. Understanding these rights is crucial for investors to ensure they can protect the value of their investments.

Common Shareholder Rights

Common shareholders are granted the following rights:

• Voting power on major issues, including the election of directors and proposals for fundamental changes such as mergers or liquidation.
• Ownership in a portion of the company, which entitles them to a share of the business profits and assets, especially in the event of dissolution.
• The right to transfer ownership, allowing shareholders to trade their stock on an exchange and providing liquidity to their investment.
• Entitlement to dividends, which may be paid out by the company's management instead of being reinvested in the firm.
• Opportunity to inspect corporate books and records, including basic documents such as company bylaws and minutes of board meetings, as well as financial statements and annual reports.
• The right to sue for wrongful acts, often in the form of a shareholder class-action lawsuit.

Additional Investor Rights

In addition to the basic rights of common shareholders, investors may have additional rights depending on the company and the type of shares they hold. These rights may include:

• Liquidation preference, which gives preferred shareholders "preferred" treatment over ordinary shares in the event of liquidation, winding up, or dissolution of the company.
• Anti-dilution rights, which protect the value of an investor's stake by granting additional shares or adjusting the amount of proceeds they are entitled to when new shares are issued at a lower price.
• Rights relating to reserved matters, giving investors the ability to veto certain important decisions, such as significant business transactions, senior appointments, litigation, or changes to the company's capital structure.
• Right to appoint board members, which is typically requested by larger or more "involved" investors.
• Share transfer restrictions, which limit a shareholder's ability to transfer their shares and are designed to keep control over who owns the company's shares and protect investors from founder departures.
• Pre-emption or subscription rights, which give existing investors the priority right to invest in future equity funding rounds and maintain their percentage ownership in the company.
• Right of first refusal, which gives shareholders the priority right to buy existing shares from another shareholder before they are transferred to a third party.
• Drag-along rights, which allow majority shareholders to force minority shareholders to sell their shares along with the majority to a specific third-party buyer.
• Tag-along rights, which give minority shareholders the right to "tag along" and sell a portion of their shares to the same buyer as the majority shareholders at the same price.

Rights in Interactions with Financial Professionals

When interacting with investment advisors, securities brokerage firms, and their representatives, investors have additional rights, including:

• The right to expect fairness and good faith performance in those interactions.
• The right to knowledge of the risks, facts, and costs of any investment recommended or sold by those entities.
• The right to advice and recommendations that align with the investor's level of experience, goals, timeline, risk tolerance, and other relevant factors.
• The right to pay a fair price for services received and to receive detailed and clear information about fees, charges, and costs.
• The right to clear, accurate, and timely account statements.
• The right to a clear description of privacy policies and protection of personal information.
• The right to expect firms to adhere to federal and state regulations and laws relating to the sale of securities, investment advice, and daily operations.
• The right to know about any interests of the other party that may create a conflict of interest.

Regulatory Protections

In the United States, the Securities and Exchange Commission (SEC) regulates the securities markets and protects investors. The Investor Protection Act of 2009 expanded the powers of the SEC and established additional protections for investors, including increased safeguards for whistleblowers and the creation of the Investor Advisory Committee to advise on regulatory priorities and initiatives to protect investors' interests.

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