Rights Offering Math: TERP, Dilution, and the Exercise Decision

This guide focuses on the shareholder math after a rights issue is announced. It complements rather than repeats a general rights-offering overview. The actual prospectus controls the subscription ratio, price, transferability, oversubscription privilege, deadlines, proration, withdrawal rights, foreign-holder treatment, and use of proceeds.

Calculate theoretical ex-rights price and value

If a holder can buy m new shares for every n old shares at subscription price S, and the pre-rights market price is P, a simplified theoretical ex-rights price is:

TERP = (n × P + m × S) ÷ (n + m)

The theoretical value transferred from each old share is P − TERP. This is not a forecast: the stock can move, fees and taxes matter, and the issuer's prospects change when it raises and spends the cash. Compare three paths—exercise, sell transferable rights, or let them lapse—using the same ownership and cash assumptions. Also model nonparticipation dilution in voting percentage, earnings per share, and book value per share.

For U.S. federal tax questions, stock-rights basis and disposition rules can be complex; use IRS Publication 550 and professional advice for the specific offering.

A rights offering is a capital raise in which a company gives its existing shareholders the right, but not the obligation, to buy additional shares, usually at a discount to the market price and in proportion to what they already own. For shareholders, it is a decision point with three options: exercise the rights, sell them if they are transferable, or let them expire. This page is for investors who received a rights notice or want to understand the mechanics before it happens. Read how the process works, weigh the benefits against the dilution math, and check the decision framework below before your rights' expiration date.

How a rights offering works

When a company needs new equity capital, it can offer new shares to its current owners first. Each shareholder receives subscription rights based on a set ratio, for example one right for every five shares held on the record date. Each right allows the purchase of new stock at a fixed subscription price during a limited window, typically a few weeks.

The subscription price is normally set below the current market price. The discount compensates shareholders for the dilution the new shares create and gives them a reason to act before the window closes. After the offer period ends, unexercised rights usually expire worthless.

A typical timeline looks like this:

1. Announcement. The company discloses the ratio, subscription price, record date, and expiration date.
2. Record date. Only shareholders of record receive rights.
3. Subscription window. Holders exercise, sell (if allowed), or ignore their rights.
4. Settlement. New shares are issued, and the company receives the proceeds.

Companies use rights offerings to pay down debt, fund projects, or shore up the balance sheet while giving loyal shareholders first claim on the new stock.

Types of rights offerings

Transferable (renounceable) rights

The rights themselves trade on an exchange during the subscription window. A shareholder who does not want more shares can sell the rights and capture part of the discount's value as cash.

Non-transferable (non-renounceable) rights

The rights cannot be sold. The holder either exercises them or lets them lapse, which makes the decision more binary and makes ignoring the offer more costly.

Oversubscription privilege

Some offerings let participating shareholders apply for shares that other holders declined. This can matter in smaller offerings where insiders want to increase their stake at the subscription price.

Standby and backstopped offerings

In a backstopped offering, an underwriter or standby purchaser agrees to buy some or all unsubscribed shares subject to the agreement's conditions, caps, termination rights, and fees. It can increase funding certainty but is not an unconditional guarantee; read the standby purchase or underwriting agreement.

Benefits of participating

• Discounted purchase price. The subscription price usually sits below the market price at announcement, so exercising can mean buying at a discount, though the market price can move during the window.
• Protection against dilution. Exercising in proportion to your holding keeps your ownership percentage roughly intact as the share count grows.
• No commission in many cases. Shares bought through the subscription agent often carry no brokerage commission.
• Priority access. Existing owners get the first opportunity before any leftover shares are placed elsewhere.

Risks and drawbacks

• Dilution if you do nothing. The new shares reduce every non-participant's ownership percentage and can pressure earnings per share.
• A discount is not free money. The stock often trades lower after the announcement, because the market reprices for the larger share count. The theoretical ex-rights price sits between the old market price and the subscription price.
• A signal worth reading. Companies raising emergency equity may be under financial stress. The reason for the raise matters more than the discount.
• Concentration risk. Exercising means putting new money into a single company you already own, which increases portfolio concentration.
• Expiration risk. Rights are time-limited. Missing the deadline in a non-transferable offer forfeits the entire value of the rights.