topic 23 bonus + rights issues

• Two ways for limited companies to increase their OSC is by issuing more ordinary shares:

  • the shares are offered to existing shareholders
  • in proportion to the number of shares held/on a pro rata basis
• Bonus issues are made when a company issues free shares to existing shareholders:

  • no payment is made for the shares
  • no money is received by the bank
  • so no change in net assets section of the SOFP
• Bonus issues turn reserves into share capital, using reserves that have built up and 'capitalising' them:

  • there is no change in the total of the equity in the SOFP
  • in equity section reserves are put in order of most flexible form: share premium then revaluation reserve
• Reasons for bonus issues:

  • directors feel that OSC doesn't reflect the net asset base
  • as a PR exercise to keep shareholders happy and reward existing shareholders for loyalty
  • to reward directors and/or managers in a bonus system
  • to reward employees in a share participation system
  • capital reserves cannot be used to pay dividends: by converting capital reserves into ordinary shares means company can pay more dividends
  • bonus issues may be considered if there is insufficient cash to pay the ordinary dividends
• Rights issues:

  • are not free -> a way for a company to raise finance
  • for existing shareholders, have a 'right' to buy them
  • shareholders can then exercise that right and buy the shares -> the shares are offered at a good price - below the current market value
  • this encourages shareholders to buy the shares and saves the company time and expense of advertising the shares to the general public
  • if shareholders do not exercise their right, the shares can be sold to a third party
• Advantages of rights issues:

  • there is no interest to pay, unlike finance through borrowing, reducing the risks of high gearing
  • it is less expensive to write to existing shareholders offering shares for sale than to advertise to the general public, known as a 'full dress issue', the cost of which can run into millions
  • existing shareholders are more likely to want to buy shares than the public as there is less guarantee the shares will sell for the desired price
  • there is no change in ownership
• Bonus issues:

  • additional shares are given free to existing shareholders
  • the capitalisation of reserves into share capital
  • issued to restructure the SOFP
  • total equity remains the same
  • (capital) reserves go down
  • stock market price of shares will fall in proportion to bonus issue
  • distributed in proportion to existing shareholding
  • control of company doesn't change
• Rights issues:

  • additional shares offered for sale to existing shareholders
  • shares have to be paid for
  • issued to raise finance - company receives payment from shares sold
  • shareholders can either buy additional shares or sell the rights on the stock market
  • total equity increases
  • share premium reserves go up
  • offer price is below the market value so stock market price may fall
  • distributed in proportion to existing shareholding, control of the company does not change