Oversubscription Privilege

An oversubscription privilege gets extended to a company’s shareholders on the issuance of a rights or warrants offering. The privilege allows shareholders to purchase any shares remaining after other shareholders have had an opportunity to purchase them.

Oversubscription privileges apply to existing shareholders. In a rights offering, a firm generally offers its existing shareholders the right to purchase a specific number shares at a discount to the current share price within a given time period. Since companies issue shares to raise money and a failure to sell all new shares in an issuance could leave a firm undercapitalized, rights issues sometimes use a form of contingency plan to deal with shareholders who decide not to exercise their right to purchase new shares. Oversubscription privileges allow shareholders additional rights to purchase a specified proportion of the unexercised shares.

Oversubscription generally describes a situation in which demand outstrips the supply of shares in a new issuance. In the case of oversubscription privileges, companies presume the oversubscription will occur among the pool of shareholders willing to exercise their right to purchase new shares. In many cases, this demand stems from shareholders’ desire to maintain their proportional ownership of a firm’s shares along with the voting rights that accompany them. Rights offerings account for this by issuing rights and oversubscription privileges in proportion to shareholders’ current holdings.

Companies use rights issues to raise cash from existing shareholders, often to pay off existing debts, make a one-time large-scale capital purchase or solve a cash flow issue. A new share issuance causes dilution, since the larger number of shares available overall decreases the value of any given share as a proportion of the whole. Current shareholders seeking to maintain their proportional holdings need to purchase a number of new shares equal to the proportion of shares they own. In addition, however, shareholders need to consider the potential loss of value in their current holdings when deciding whether the discounted price offered for new shares makes sense.

Investors should also investigate the reasons behind a rights issuance before exercising those rights. Rights issuances can be a sign of financial trouble, especially when companies find themselves unable to pay down existing debt. However, rights offerings do not always indicate a troubled company. Wise investors will research the situation to ensure they have a full picture of the benefits and risks involved in purchasing the discounted shares offered in a rights issuance.

In general, shareholders offered a rights issuance have three choices: they can exercise their rights, ignore their rights and take a hit from dilution, or, in some cases, sell the rights to other shareholders or back to an underwriter.