Bonus Issue vs Rights Issue

What is the difference between bonus issue and right issue?

Both bonus issues and rights issues are methods through which a company can raise additional capital or restructure its equity base, but they are fundamentally different in terms of how they are structured and the implications for both the company and its shareholders.

For bonus issue, new shares are issued by transferring company's reserves into share capital. The number of free shares is usually distributed pro rata to existing stockholder. For example, if a company declares a one for three bonus issue, it means that for every 3 shares held, a shareholder will receive one free share.

A rights issue is an issue of new shares to existing shareholders at a price that is lower than the market price listed in the stick exchange, and therefore making it attractive to the existing shareholders.

Below is a detailed comparison of these two methods of issuing shares:

1. Definition and Purpose

Bonus Issue (or Scrip Issue): A bonus issue refers to the distribution of additional shares to existing shareholders, free of charge, in proportion to their existing holdings. It is essentially a "gift" from the company to its shareholders, where new shares are issued without requiring any payment. The main purpose of a bonus issue is to capitalize retained earnings or reserves, which means the company uses its existing profits or reserves to issue additional shares. A bonus issue does not raise fresh capital for the company; instead, it increases the number of shares outstanding.

Rights Issue: A rights issue involves offering new shares to existing shareholders at a discounted price, usually below the current market price, in proportion to their existing holdings. Shareholders are given the "right" to purchase these new shares, but they must pay for them. The primary purpose of a rights issue is to raise new capital for the company, which can be used for various purposes such as funding growth, paying down debt, or acquiring assets. Rights issues result in an actual influx of cash into the company's balance sheet.

2. Impact on Shareholders' Ownership

Bonus Issue: In a bonus issue, all existing shareholders receive additional shares based on the number of shares they already own. However, since these new shares are issued without charge, the overall value of each shareholder’s investment remains unchanged. The total value of the shareholder’s holding is spread across a larger number of shares, so the price per share typically drops in proportion to the bonus issue. For example, if a company declares a 1:1 bonus issue (one new share for every share held), the shareholder will own twice as many shares, but the value of each share will be halved.

Rights Issue: In a rights issue, shareholders are offered new shares at a discounted price in proportion to their current holdings, but they must pay for these shares. If a shareholder chooses to exercise their rights and buy the new shares, their proportional ownership in the company is maintained. However, if a shareholder decides not to participate, they risk having their ownership diluted, as other shareholders who exercise their rights will increase their stake in the company.

3. Capital Raised

Bonus Issue: No fresh capital is raised in a bonus issue. Instead, the company issues new shares using its existing reserves or retained earnings. Essentially, the company is converting its profits or other reserves into share capital, but this does not result in any inflow of cash into the company’s coffers.

Rights Issue: A rights issue is designed to raise fresh capital for the company. Shareholders are asked to pay for the new shares they purchase at the discounted price. The funds raised through a rights issue are usually directed toward specific uses, such as financing expansion, reducing debt, or funding capital expenditures.

4. Price of New Shares

Bonus Issue: New shares issued in a bonus issue are given to shareholders free of charge. There is no payment involved, and the value of the new shares is typically accounted for by reducing the company's reserves (such as retained earnings). However, after the bonus issue, the market price of the shares often adjusts downward to reflect the increased number of shares in circulation.

Rights Issue: The new shares offered in a rights issue are sold to shareholders at a discounted price, which is lower than the current market price. The discounted price is meant to provide an incentive for shareholders to purchase additional shares. This price is fixed before the rights issue and is typically set at a level that makes it attractive for shareholders to buy the new shares.

Example:

ABC Ltd has 500,000 $1 ordinary shares as at 31 December 2010. The company makes a rights issue to its existing shareholders by offering 1 new share for every five existing shares held. The new shares are issued at $1.50 each.

So, the rights issue is 1 for 5,
and with 500,000 shares, the rights issue =100,000 shares.
The amount received from the issue = 100,000 shares x $1.50 = $150,000.