Rights Offering Explained: Subscription Rights, TERP, and What Shareholders Should Know

A rights offering is one of the less-glamorous corners of capital markets, but for shareholders of a company that launches one, understanding the mechanics can be the difference between protecting your ownership stake and inadvertently giving it away. This guide explains how rights offerings work from the ground up, including how to calculate the theoretical ex-rights price, what the oversubscription privilege means, and the practical decision every shareholder must make when they receive subscription rights.

What Is a Rights Offering?

A rights offering is a capital-raising transaction in which a company offers its existing shareholders the right to purchase additional shares at a discounted price, typically below the current market price, in proportion to their existing holdings.

These rights are called subscription rights. They are legal instruments - essentially short-lived options - that give the holder the ability to "subscribe" to new shares at the predetermined subscription price before a specified expiration date.

The key word is "existing shareholders." Unlike a secondary offering in which new shares are sold to the general public through underwriters, a rights offering gives current shareholders first access. This is by design. It allows shareholders to maintain their proportional ownership in the company if they choose to participate.

Why Companies Use Rights Offerings

Companies raise capital through several mechanisms. A secondary offering sells new shares to institutional investors through investment banks. A private placement sells shares directly to a small group of accredited investors. A rights offering sells shares to the existing shareholder base.

Rights offerings are less common in the United States than in Europe, Australia, and parts of Asia, but they are used in specific circumstances where they make more sense than a traditional secondary.

Avoiding Dilution of Loyal Shareholders

A secondary offering dilutes shareholders regardless of whether they participate. In a rights offering, shareholders who exercise their rights avoid dilution entirely because they are buying new shares at the same proportional rate as the offering itself.

Lower Underwriting Costs

Traditional secondary offerings involve investment bank underwriting fees that can run 3% to 7% of proceeds. A rights offering can be completed with much lower direct costs, though companies sometimes hire a dealer-manager to assist and may pay standby underwriting fees for a backstop arrangement.

Speed and Certainty in Some Markets

In markets where rights offerings are standard practice, they can be completed relatively quickly once regulatory filings are in order. They also offer a degree of certainty because the existing shareholder base has a known stake in the company.

Financial Distress Situations

Rights offerings are frequently used by companies in or near financial distress that need to raise equity capital but may not have access to the public markets on attractive terms. Existing shareholders are given the choice to put in more money or accept dilution.

The Key Terms and How They Work

Understanding a rights offering requires knowing five core concepts.

Subscription Rights

Every shareholder of record as of the record date receives one subscription right for each share they own. These rights are distributed automatically into brokerage accounts, similar to how spin-off shares are distributed. Each right entitles the holder to purchase a fraction of a new share (or in some structures, N rights are required to purchase one new share) at the subscription price.

For example, suppose a company issues 1 right per existing share and requires 5 rights to purchase 1 new share at $18 per share. If you own 500 shares, you receive 500 rights and can subscribe for 100 new shares at $18 each.

Subscription Price

The subscription price is the discounted price at which new shares are offered. It is set below the current market price to give shareholders an incentive to exercise. The deeper the discount, the more attractive the rights are, but a deep discount also signals that the company may be in a weaker negotiating position.

Typical subscription price discounts range from 10% to 25% below the current market price. Distressed situations can see deeper discounts.

Record Date and Ex-Rights Date

The record date is the date by which you must be a shareholder to receive rights. The ex-rights date is the trading date on which the stock begins trading without the right attached, analogous to the ex-dividend date for a dividend. If you purchase shares on or after the ex-rights date, you do not receive the subscription rights.

Subscription Period

Rights are not permanent. They expire. The subscription period is the window of time during which rights holders must exercise their rights or let them expire. This window is typically 16 to 21 days for U.S. companies, though it varies by jurisdiction.

Oversubscription Privilege

Many rights offerings include an oversubscription privilege (sometimes called an over-allotment right). This allows shareholders who exercise all of their basic subscription rights to also request additional shares beyond their pro-rata allocation. If other shareholders do not exercise their rights, the unexercised shares become available and are allocated to over-subscribers, typically on a pro-rata basis among those who requested more.

The oversubscription privilege is valuable in situations where the subscription price represents a meaningful discount to intrinsic value. It allows confident shareholders to increase their position beyond their standard allocation.

How to Calculate the Theoretical Ex-Rights Price (TERP)

The theoretical ex-rights price (TERP) is the estimated fair value of a share after the rights offering is completed, assuming full subscription. It is "theoretical" because the actual post-offering stock price depends on market conditions, but TERP gives you a rational starting point.

The formula is:

TERP = (Market Value of Existing Shares + Subscription Proceeds) / Total Shares After Offering

Here is a worked example.

Suppose a company's shares are trading at $30. The company has 10 million shares outstanding. It announces a rights offering that will issue 2 million new shares at a subscription price of $22. Shareholders receive 1 right per share; 5 rights are required to purchase 1 new share (so the offering is 10 million rights to purchase 2 million shares).

Step 1: Calculate the market value of existing shares. 10,000,000 shares x $30 = $300,000,000

Step 2: Calculate the subscription proceeds from the offering. 2,000,000 new shares x $22 = $44,000,000

Step 3: Add the values and divide by total shares after the offering. ($300,000,000 + $44,000,000) / 12,000,000 shares = $344,000,000 / 12,000,000 = $28.67

The TERP is $28.67. Notice this is below the current price of $30. That makes sense: the company is issuing new shares at a discount, which dilutes the per-share value. The stock should trade near $28.67 after the ex-rights date, all else equal.

The Value of One Right

You can also calculate the theoretical value of each individual right.

Value of one right = (Pre-ex-rights price - TERP) = $30.00 - $28.67 = $1.33

Alternatively: Value of one right = (Market Price - Subscription Price) / (Number of rights needed to buy one share + 1) = ($30 - $22) / (5 + 1) = $8 / 6 = $1.33

Both methods produce the same result.

Tradeable vs. Non-Tradeable Rights

Not all rights offerings work the same way. Some rights are tradeable on a stock exchange; others are not.

Tradeable rights can be bought and sold in the secondary market during the subscription period. This is important for shareholders who do not want to exercise their rights but also do not want to forfeit value. They can sell their rights to another investor who does want to subscribe. Tradeable rights have their own ticker symbol for the duration of the subscription period.

Non-tradeable rights cannot be sold. A shareholder who does not want to exercise simply lets them expire. This is less shareholder-friendly because it transfers value from non-exercising shareholders to the company (and indirectly to exercising shareholders).

When evaluating a rights offering, check whether the rights are tradeable. If they are, you have flexibility. If they are not, the decision to exercise or let expire is starker.

Should You Exercise, Sell, or Let Rights Expire?

This is the practical question every shareholder faces. The theoretically correct answer depends on your view of the company and your cost of capital.

Exercise Your Rights

Exercise when you believe the intrinsic value of the business exceeds the subscription price and you want to maintain your proportional ownership. If you were willing to own the stock at $30 and can now buy more at $22, exercising is consistent with your original thesis - assuming that thesis has not changed.

Be aware: exercising requires putting up additional capital. If you do not have the cash available, exercising may not be feasible.

Sell Your Rights (if tradeable)

If the rights are tradeable, selling them preserves the economic value without requiring you to commit additional capital. In the example above, you would receive approximately $1.33 per right. Selling the rights is economically equivalent to exercising them from a pure value perspective (assuming rights trade at theoretical value), but without the need to inject more cash.

In practice, rights sometimes trade slightly below theoretical value due to illiquidity and the short time window. If you sell rights, do so early in the subscription period rather than waiting until near expiration when you may face wider bid-ask spreads.

Let Rights Expire (the worst option in most cases)

Letting non-tradeable rights expire is simply forfeiting value. Letting tradeable rights expire is even worse - you are giving away something that has a market price. The only rational case for letting rights expire is if the subscription price is above the market price (making the rights worthless anyway, which sometimes happens if the stock declines below the subscription price during the offering period).

What Happens If the Stock Falls Below the Subscription Price?

This is a real risk in rights offerings. If the stock price falls below the subscription price during the subscription period, the rights go "out of the money" and have zero intrinsic value. Subscribing would mean paying more than market price for shares you could simply buy cheaper in the open market.

In these situations, rights expire worthless. Shareholders who neither exercised nor sold are no worse off than if they had let them expire, since there was nothing to sell anyway.

This scenario is most common in distressed situations where the company's stock continues to fall during the offering. It is one reason rights offerings carry meaningful risk for both the company and its shareholders.

The Backstop Arrangement

Many rights offerings, especially those by smaller companies or distressed issuers, include a backstop commitment from a large investor - often a private equity firm, a major existing shareholder, or an activist. The backstop investor agrees to purchase any shares that are not subscribed by the public rights holders, guaranteeing the company raises its full target amount.

In exchange, the backstop investor typically receives a fee (often 2% to 5% of the backstop amount) plus the right to purchase additional shares at the subscription price for any unsubscribed shares. This arrangement gives the company certainty of proceeds while giving the backstop investor the opportunity to increase its stake cheaply if participation is low.

From a shareholder perspective, identifying who is backstopping an offering can be informative. A credible, value-oriented backstop investor who is willing to absorb all unsubscribed shares is a signal worth noting.

Rights Offerings vs. Other Capital Raises

How to Track a Rights Offering

When your broker notifies you of a rights offering, the notification will include:

• The subscription price
• The subscription ratio (how many rights are needed to subscribe for one new share)
• The record date
• The subscription period expiration date
• Whether the rights are tradeable
• Whether an oversubscription privilege exists

You typically have until the expiration date to instruct your broker to exercise. Most brokers require instructions a few days before the stated deadline to allow for processing time. Do not wait until the last minute.

If you hold shares in multiple accounts, check each account separately - rights are distributed to each account independently.

Key Takeaways

• A rights offering is a capital raise in which existing shareholders receive the right to purchase new shares at a discounted subscription price, proportional to their current holdings.
• Shareholders who exercise their rights in full avoid dilution; those who do not exercise (and cannot sell tradeable rights) will see their ownership percentage decline.
• The theoretical ex-rights price (TERP) is calculated by dividing the total post-offering value (existing market cap plus subscription proceeds) by total shares outstanding after the offering.
• The value of each right can be estimated as the difference between the pre-ex-rights price and the TERP, or equivalently as the spread between market price and subscription price divided by (rights per share plus one).
• Tradeable rights should almost always be exercised or sold before expiration - letting tradeable rights expire is forfeiting value.
• The oversubscription privilege allows fully participating shareholders to request additional shares beyond their basic allocation, filled from any unsubscribed shares.
• Backstop arrangements - where a large investor agrees to purchase all unsubscribed shares - give companies certainty of proceeds and can be a signal worth examining.
• Rights offerings are common in distressed or highly leveraged situations; always evaluate whether the capital raise solves the underlying problem or simply delays it.
• Equity Rank's multi-method valuation framework helps you assess whether a company's fair value exceeds the subscription price before you commit additional capital.