Stock Market Investing 10 Minute Guide

Subscription Rights

Subscription rights are formalized promises from a company to sell its stock to its current stockholders at a price reduced from the market price in the event of new stock being issued.

Plain English

Subscription rights are a type of financial instrument that a company grants to its current shareholders, giving them the option to buy future issues of company stock at a discount price.

For example, let's say you own 100 shares of XYZ Company for which you paid $8 per share. XYZ Company issued only 200 shares to begin with, so you effectively bought and own half of XYZ Company. Now the price of XYZ Company has risen to $10 per share, and XYZ Company decides that it wants to raise some more cash to open a new Widget factory in a nearby town. So, the company offers another 200 shares of stock for sale. Your half-ownership of XYZ Company has been effectively cut to one-fourth with the stroke of a pen. "That's not fair," you cry. "I bought those 100 shares initially so that I could have half-ownership in the company."

XYZ Company certainly doesn't want to cause hard feelings in those people who already own its stock, because a sell-off by angry shareholders could lower the price of the stock, and the company would thereby effectively lose all the money it had stood to gain by issuing new stock.

To address this type of situation, XYZ Company decides to issue subscription rights to its current shareholders. By issuing subscription rights, XYZ Company gives its investors "coupons" with which they can buy shares of the newly issued 200 shares for $8 per share rather than the $10 everyone else has to pay. These coupons , or subscription rights, are usually issued based on the number of shares already held by the current investor. In the same example, you own 100 shares, and XYZ Company has decided that for every 5 shares held by a current investor the investor will be issued one subscription right. You therefore have the right to purchase 20 shares for $8 each.

If you buy 20 additional shares at $8, it will cost you $160. That's a big break from the $200 it would cost a new investor to purchase those same 20 shares at $10 per share. And the value of your new shares is still $200, just as if you had paid the new-investor price of $10 per share. Thus you immediately make $40.

Immediate Gratification

The advantage of subscription rights is that you can make money from them even if you have no interest in purchasing additional stock. Let's say XYZ issues you 20 subscription rights and, truthfully, you have no intention of using them. Then let's say I'm an investor who wishes to purchase XYZ Company stock. You offer to sell me your 20 subscription rights for $1 each. Yes, you can do that because subscription rights are fully transferable; in other words, you can use them or dispose of them as you see fit.

I pay you $20 for your subscription rights and then buy the 20 shares at $8 each (20 — $8 = $160). Adding in the $20 I paid you initially, my total price is $180. I still got the stock $20 cheaper than if I had bought it in the open market at $10 per share. You've just made $20 from selling me something you didn't want anyway. As this example shows, subscription rights are really popular. They're like getting an unexpected gift. You are, however, still no longer half-owner in XYZ Company, but then it's not a perfect world.