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Subscription Right Definition

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What Is a Subscription Right?

A subscription right is the right of existing shareholders in a company to retain an equal percentage ownership by subscribing to new stock issuances at or below market prices. The subscription right is usually enforced by the use of rights offerings, which allow shareholders to exchange rights for shares of common stock at a price generally below what the stock is currently trading for.

Subscription rights are also known as the “subscription privilege,” “preemptive right,” or “anti-dilution right” of the shareholder. A subscription rights issue increases the number of shares in the market, thus leading to a dilution in each share’s value.

Key Takeaways

  • Subscription rights allow a company’s shareholders to retain an equal percentage of ownership when a company issues a secondary offering of its stock.
  • A subscription right allows existing shareholders in a company to purchase shares of the secondary offering—usually at a discounted price—before shares are offered to investors in the broader market.
  • If shareholders do not exercise their subscription rights during the specified time frame, their ownership will be diluted.

How Subscription Rights Work

Subscription rights are not necessarily guaranteed by all companies, but most have some form of dilution protection in their charters. If granted this privilege, shareholders may purchase additional shares on a pro-rata basis before they are offered to the secondary markets. This form of dilution protection is usually good for up to 30 days before a company seeks new investors in the broader market.

If shareholders do not exercise their subscription rights, their ownership will be diluted. Most subscription rights are not transferable unless allowed by the issuer. If they are transferable, they can be traded on an exchange. Also, oversubscription privileges are offered in some cases whereby shareholders who have fully exercised their rights can subscribe to additional shares, again on a pro-rata basis.

If at least 20% of the shares outstanding are offered at a discount, the Securities and Exchange Commission (SEC) does not require that the shareholders formally approve the subscription rights offering. Investors receive notification of their subscription right by mail (from the company itself) or through their brokers or custodians.

Criticism of Subscription Rights

Also, the announcement of the secondary offering often leads to a decline in share price as some investors respond to the news by selling off the stock. The prospect of a share dilution will generally be negative to a stock price and to the original investors’ sentiment.

There are several warning signs investors should be aware of that might indicate a company is considering rolling out a secondary offering. For example, if a company is having difficulty raising money to cover expenses or fund large projects, management might decide to issue new stock to cover the emerging capital and debt needs. Investors need to watch for the signs of potential share dilution and understand how this might impact their investments.

The dangers of share dilution can also occur when a company issues stock options to employees or board members. Additionally, share dilution can occur as part of a dilutive acquisition when a company needs to issue additional shares in order to pay for the purchase of another company.

Example of a Subscription Right

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