Equity finance is one of a company’s most important sources of finance. Equity finance can have many advantages and disadvantages for a company.
One of the main disadvantages of equity finance for a company is that equity finance dilutes the ownership and control of the company.
Usually, existing company owners may not want to dilute the ownership and control of the company by issuing new shares.
Companies can opt for other sources of finance as well, such as debt finance in these cases.
However, companies can also use the right share issues to tackle the problem while also obtaining equity finance.
Right Share Issues
A right share issue is an invitation that a company gives to its existing shareholders to purchase new shares of the company based on the number of their existing shares held.
Right issues benefit a company as they allow it to raise equity finance without diluting its ownership.
However, the right issues are an invitation and can be rejected by the shareholders.
Rights issues are also cheaper for the company than issuing ordinary shares.
This is because the company does not have to pay different types of market fees to issue the shares. The company can use its existing shareholders to easily raise finance.
Rights issues are also beneficial to the shareholders as the shares offered to the shareholders in rights issues are at a lower price than the market price of the share.
Shareholders can also transfer the rights and sell them in the open market.
Shareholders can also avail of the option to buy shares at a discounted price and sell the shares in the market for a profit.
Accounting Entry
The accounting entry for the right share issue is the same as the accounting entry for normal share issues but with a lower price.
For example, ABC Co. has 100,000 issued shares with a nominal value of $10 per share and a market value of $15 per share.
The company invites its shareholders to a rights issue of 1 share for every five shares for $10 per share.
This means the company is offering its shareholders a total of 20,000 (100,000 x 1 / 5) shares at a discount of $5 ($15 – $10).
Assuming the shareholders accept all the issues, the accounting entry will be as follows:
Dr Bank (20,000 x $10) 200,000
Cr Share Capital (20,000 x $10) 200,000
For the same example, if the right share issue price is $12 instead of $10, the accounting entry will be as follows:
Dr Bank (20,000 x $12) 240,000
Cr Share Capital (20,000 x $10) 200,000
Cr Share Premium (20,000 x ($12 – $10)) 40,000
In the above example, while the shares are issued at a discount from the market value of the shares, i.e. $15, the shares are still issued at a value above the nominal value.
Therefore, any amount exceeding the nominal value of the share will be taken to the share premium account.
Conclusion
Equity finance is one of the different sources of finance for companies. While it may have many advantages, equity finance may come with its own disadvantages as a source of finance.
One of these disadvantages is the dilution of ownership of the company. To tackle this issue, rights share issues are used.
Rights issues are shares offered to exist shareholders of the company at a lower price than the market value of the shares.
The accounting entry for the issue of the right shares is the same as for ordinary shares issues.
