Rights & Bonus Issues for Limited Companies

1. A rights issue raises cash (existing shareholders pay for the new shares, usually below market price); a bonus issue raises no cash (the shares are free, funded from reserves).
2. A rights issue increases total equity (cash comes in); a bonus issue leaves total equity unchanged (reserves are converted into share capital).

New shares = 800,000 ÷ 4 = 200,000. Cash raised = 200,000 × 0.70 = $140,000. Share capital = 200,000 × 0.50 = $100,000; share premium = 200,000 × 0.20 = $40,000.

Bonus shares = 1,000,000 ÷ 10 = 100,000; nominal value = $100,000.

Effect on total equity: none — the share premium falls by $100,000 and share capital rises by $100,000, so total equity is unchanged. No cash is raised.

The revaluation reserve cannot be used for a bonus issue. Use the share premium first, then retained earnings for the balance:

• Share premium: $90,000.
• Retained earnings: 150,000 − 90,000 = $60,000.

Why the price per share falls. A bonus issue raises no cash and brings no new assets into the company, so the total value of the company is unchanged. However, that same total value is now divided among a larger number of shares, so the value per share falls — for example, a 1-for-4 bonus issue increases the number of shares by 25%, so each share is worth roughly 1/1.25 of its former price.

Do shareholders gain? Each shareholder receives more shares, but they are shares of a company worth the same as before. So the total value of each shareholder's holding is unchanged — they are no richer in total.

Possible benefits. They may still gain indirectly: the lower price per share can make the shares more marketable (easier to buy and sell), and capitalising reserves into share capital can signal confidence and make a portion of the reserves permanent.

Conclusion. A bonus issue does not increase shareholders' total wealth — it simply gives more shares at a lower price each — but it may improve marketability and the company's capital structure.

Arguments for a rights issue.

• It raises the cash needed, and is cheaper than a public share issue (no prospectus or underwriting costs).
• Shares are offered to existing shareholders, so if they take up their rights, control remains with them.
• The price is usually set below market price, encouraging shareholders to subscribe.

Arguments against / risks.

• Shareholders must find the cash to take up their rights; not all may be willing or able.
• If some do not take up their rights, their shareholding is diluted and control can shift.
• The larger number of shares may lower the share price slightly.
• If shareholders cannot fund it, the company may not raise the full amount, and might then need a public issue or a loan/debenture instead.

Conclusion. A rights issue is a good, low-cost way to raise cash while preserving control, provided the shareholders are willing and able to subscribe. If there is doubt about take-up, or if the company prefers not to dilute equity, a debenture/loan (keeping control, raising gearing) could be considered instead.

(1) Rights issue (1-for-3 on 300,000 = 100,000 shares at $1.40):

• Share capital += 100,000 × 1 = 100,000 → 400,000.
• Share premium += 100,000 × 0.40 = 40,000 → 120,000.

(2) Bonus issue (1-for-5 on 400,000 shares = 80,000 shares, $1 each =$80,000):

• Use share premium: 120,000 − 80,000 = 40,000.
• Share capital += 80,000 → $480,000.

Final: share capital $480,000; share premium $40,000.

(a) Cash: a bonus issue has no effect on cash — the shares are issued free, funded by transferring reserves into share capital, so no money is received or paid.

(b) Distributable reserves: if the bonus issue uses a revenue reserve (e.g. retained earnings or general reserve), the company's distributable reserves are reduced, lowering the amount available for future cash dividends. If it uses the share premium (a capital reserve), distributable reserves are not affected. Either way, the amount used is permanently locked into share capital, which cannot be returned to shareholders as easily.

A bonus issue is the issue of free shares to existing shareholders, in proportion to their holdings, funded out of the company's reserves rather than by new cash. It converts reserves into share capital and raises no cash.

A company may make a bonus issue for several reasons even though no cash is raised:

• To reward loyal shareholders with additional shares without them paying.
• To capitalise large reserves — converting reserves (such as share premium) into permanent share capital, which cannot be easily distributed, signalling stability and that the funds are committed to the business.
• To reduce the market price per share (more shares of the same company), making the shares more marketable and easier to trade, which can widen ownership.
• To bring the issued share capital closer to the value of the net assets, presenting a more realistic capital structure.

So although a bonus issue does not raise finance or make shareholders richer in total, it can improve marketability, capital structure and shareholder goodwill.