rights offerings and warrants

In short

I once watched a neighbor open a letter from a company he owned shares in and toss it in the trash, thinking it was junk mail. It was an invitation to buy more shares at a discount, and it had a deadline. If you hold stock and get a notice about a rights offering, read it the day it arrives. A right is a short lived offer to buy new shares at a set price, and it can expire worthless if ignored. A warrant is a longer lived offer of the same kind, with a price and a date fixed in advance. Either one can be sold, if the rules allow, instead of used. Your broker and the company's filings will tell you the exact terms. Take it slow, and do the arithmetic before you act.

The whole of it

What it is

A friend of mine once said that a company asking for money is a lot like a church asking for a new roof. It tells its members first, and it gives them first call. That is the spirit of a rights offering. A company wants to raise cash, so it offers its current shareholders the chance to buy new shares before anyone else does. Each share you own earns you one right, or a fraction of one. The offer comes with a subscription price, which is the price you pay per new share. That price is usually set below the market price, so the offer looks like a bargain. There is also an expiration date, and the window is often just a few weeks. Miss it, and the right is gone.

A warrant is a cousin of the right. If you are holding a warrant, you own a contract that lets you buy shares at a fixed price, called the exercise price, until a fixed date. Companies often attach warrants to bonds or newly issued stock as a sweetener. Warrants can last for years. A right is a sprint. A warrant is a long walk.

Both are issued by the company itself. That sets them apart from the options you may have seen traded on an exchange, which are contracts between investors. When a warrant is exercised, the company creates brand new shares and sells them to the holder. That means the total share count goes up, and each existing share becomes a slightly smaller slice of the whole.

How it works

If you are a shareholder on the record date, you receive the rights. The record date is the day the company checks its books to see who owns the stock. Your broker usually credits the rights to your account, and a notice follows. You then have three choices. You can exercise the rights, which means paying the subscription price for new shares. You can sell the rights, if they trade on an exchange or if your broker offers a way to sell them. Or you can do nothing, and let them lapse.

Some offers carry an over subscription privilege. That lets a shareholder ask for extra shares beyond the basic amount, in case other holders leave some unclaimed. The company decides how to hand those extras out, and the offering documents spell it out.

Here is the part that trips folks up. When new shares are sold at a discount, the market price of the old shares tends to drift down. The company now has more shares out there, and the extra cash does not always make up the difference right away. If you skip the offer entirely, your ownership slice shrinks and nothing replaces it. That is called dilution. If you use or sell your rights, you can offset some of that loss. Selling the rights lets you collect value for what the offer is worth, even if you do not want more shares.

Warrants work with their own timing. The holder may exercise at any point before the expiration date, or only on certain dates, depending on the terms. Paying the exercise price turns the warrant into stock. A warrant with an exercise price above the current stock price has no exercise value at the moment. It may still be worth something, because the stock could rise before the date runs out. A warrant past its expiration is worth nothing at all.

Taxes can enter the picture too. Rights and warrants may be treated in special ways, and the cost basis of your old and new shares can shift. The IRS explains the general rules for stock, rights, and basis in Publication 550, Investment Income and Expenses. A tax professional can tell you how it applies to your case.

The numbers, and where to find yours

The terms of any offer sit in documents the company files with the Securities and Exchange Commission. You can search them for free on the SEC's EDGAR database. Look for a prospectus or a Form 8-K describing the offer. The key figures are the subscription or exercise price, the ratio of rights to shares, the record date, and the expiration date. Your broker's notice should repeat them. If the notice and the filing disagree, call the broker and ask.

For your own holdings, check your brokerage statement for the number of shares you own and any rights or warrants credited to you. Your cost basis shows on the same statement or on Form 1099-B at tax time.

A worked example

Let me tell you about a woman named Ruth, who owns 200 shares of a small utility company. The stock trades at $40 a share, so her holding is worth 200 shares at $40, which is $8,000. The company announces a rights offering. Each share earns one right, and every 4 rights let a holder buy 1 new share at $32.

Ruth has 200 rights. At 4 rights per new share, that is 200 divided by 4, or 50 new shares she may buy. At $32 a share, the cost is 50 times $32, which is $1,600.

If she exercises, she holds 250 shares. The company has raised new cash, and the market price may shift. Say the stock settles at $38. Her 250 shares would then be worth 250 times $38, which is $9,500. She paid in a total of $8,000 in old value plus $1,600 in new money, or $9,600. So at $38 she is down $100 on paper. The discount did not fully protect her, which is exactly why she checks the math rather than assuming.

Now suppose Ruth would rather not spend the $1,600. If her rights trade at, say, $1.50 each, selling all 200 brings in 200 times $1.50, which is $300. Her old shares may sag in price, but the $300 softens the blow. That price is made up for the story. Real prices come from the market.

Where it goes wrong

I have known careful people to lose money here, and it was never from carelessness about big things. It was the little deadline. The most common slip is simply missing the date. A right that expires is gone for good. The second slip is believing the discount equals a free gain. The share price often falls to meet the new price, so the bargain may be smaller than it looks.

Another trap is forgetting about cash. If you exercise, the money leaves your account right away, and the broker may set an earlier internal deadline than the company does. Ask about it. Warrants bring their own trouble. Some holders let them run out because the paperwork felt confusing, and the whole value vanished.

Last, rights and warrants from small or shaky companies can be hard to sell. A thin market means few buyers. The terms may also change, so always read the latest filing, not an old summary.

Questions to answer before you leave this page

Do you know the record date, the subscription price, and the expiration date for any offer you hold? Have you worked out what exercising would cost, using your own share count and the real ratio? Does your broker allow you to sell the rights, and by what day? Have you checked how the new shares would change your cost basis, or asked a tax professional about it? And if you do nothing, have you figured out how much of your ownership slice you would give up?