What Is a Rights Issue? TERP, Pre-Emption Rights and Dilution Explained

Short answer: A rights issue is a capital increase in which a listed company offers new shares to its existing shareholders in proportion to what they already own, at a subscription price below the current market price. Because those pre-emption rights are tradable, the share price resets to a blended level called the theoretical ex-rights price (TERP), and the gap between the old price and TERP is exactly what one right is worth. A shareholder who either subscribes or sells their rights is, in theory, no worse off; only a shareholder who does nothing is genuinely diluted.

Rights issues are one of the most reliably misunderstood topics in equity capital markets interviews, partly because the arithmetic is simple but the intuition is not. Candidates who have memorised the TERP formula still stumble when asked whether the share price drop hurts shareholders, or why a company would not simply place shares with institutions overnight instead. This guide works through what a rights issue actually is, what TERP measures, the three distinct meanings of the word dilution, and how the structure compares to a placement or an accelerated bookbuild.

What a rights issue actually is

A company that needs equity capital has a menu of options. It can issue shares to a small group of institutional investors, it can run a full public offering, it can issue a convertible bond that becomes equity later, or it can go back to the people who already own the business and offer them the first refusal. That last route is the rights issue, and in most European markets it is the default for any raise of meaningful size.

The offer has three defining parameters. The ratio says how many new shares each shareholder may buy per share held, for example one new share for every four existing shares, written as 1-for-4. The subscription price is the fixed price at which those new shares are offered, always at a discount to the prevailing market price. The subscription period is the window, typically two to three weeks in Europe, during which shareholders decide.

The mechanics from announcement to settlement

On announcement day the terms are published and the shares still carry the right to participate, which is why the last such price is called the cum-rights price. On the ex-date the rights detach and begin trading as a separate instrument, often called nil-paid rights because the holder has not yet paid the subscription price. During the subscription period a shareholder can take up the rights and pay, sell the rights in the market, or do nothing. At the end, any rights not exercised lapse, and in most structures the underwriting banks buy the corresponding shares, which is what makes the proceeds certain.

That certainty is the reason companies pay underwriting fees of roughly 1.5% to 3.0% of gross proceeds. If the money is earmarked for repaying acquisition debt or curing a covenant, the lender needs to know it will arrive, and only an underwritten capital increase provides that. The worked example in our case study on a rights issue with TERP and dilution calculations runs the full arithmetic on a EUR 1.0bn deleveraging raise, including the fee drag between gross and net proceeds.

Why pre-emption rights exist at all

Pre-emption is a shareholder protection written into company law across most of Europe and into listing rules elsewhere. The logic is straightforward: if a company can issue new shares to whomever it likes at a discount, management can dilute existing owners at will, and in the worst case can hand economic value to a favoured investor. Requiring that new shares be offered first to existing holders, pro rata, removes that discretion.

Boards do usually hold a limited non-pre-emptive authority, granted at the annual general meeting, allowing them to issue perhaps 10% of share capital without offering it around first. That headroom exists for speed, not for size. It is enough for an opportunistic top-up and nowhere near enough for a transformational capital increase, which is the structural reason large raises take the rights issue route.

TERP: the price the market resets to

The theoretical ex-rights price is the weighted average of the old shares at the old price and the new shares at the subscription price. Written out:

TERP = [(Existing Shares x Cum-Rights Price) + (New Shares x Subscription Price)] / (Existing Shares + New Shares)

A worked example

Take a company with 200.0m shares trading at EUR 25.00, announcing a 1-for-4 rights issue at a subscription price of EUR 20.00.

TERP comes out at EUR 6,000.0m divided by 250.0m shares, or EUR 24.00. The share price appears to have fallen by EUR 1.00, and this is where most of the confusion starts.

Why the price fall is not a loss

The market capitalisation did not fall. It rose from EUR 5,000.0m to EUR 6,000.0m because EUR 1,000.0m of cash walked in the door. What changed is that the same, now larger, pot of value is spread across 25% more shares. The per-share price has to fall for the arithmetic to hold, in exactly the same way that a share split lowers the price without destroying anything.

This distinction between the value of the whole business and the value of one slice of it is the same conceptual muscle tested by enterprise value questions and by the enterprise value versus equity value distinction. A rights issue raises equity value by the amount of cash raised and, if the proceeds repay debt, leaves enterprise value broadly unchanged, which is a point worth making explicitly if an interviewer pushes.

TERP has practical uses beyond the interview. Index providers apply a TERP adjustment factor, here 24.00 divided by 25.00, or 0.96, to restate the historical share price series so that charts and performance figures remain comparable across the capital increase. Analysts do the same to their target prices, and forgetting to do so is a common source of apparently absurd upside numbers in the days after a rights issue is announced.

What one right is worth

The value of a single right is the difference between the cum-rights price and TERP. In the example above, EUR 25.00 minus EUR 24.00 gives EUR 1.00 per existing share held.

There is a second route to the same answer. One new share can be bought for EUR 20.00 when it will theoretically be worth EUR 24.00, an embedded gain of EUR 4.00. Because four rights are needed to subscribe for one new share, that EUR 4.00 divides down to EUR 1.00 per right. The two calculations agreeing is a useful sanity check, and interviewers sometimes ask for both to see whether a candidate understands the ratio or has simply memorised one formula.

The three choices a shareholder faces

The tradability of nil-paid rights is what makes the pre-emptive structure fair, and it is the single most important point to land in an interview. In practice many jurisdictions add a further protection: lapsed rights are sold on behalf of non-responding shareholders through a rump placement, and the proceeds above the subscription price are returned to them. In reality, therefore, even the passive shareholder is often partially compensated, though never as reliably as one who acts.

Three different things people mean by dilution

Much of the confusion around capital increases comes from the word dilution carrying at least three meanings that behave differently.

Ownership dilution

A 1-for-4 issue lifts the share count by 25%. A shareholder who does not subscribe sees their stake fall from, say, 5.00% to 4.00%. This is unavoidable arithmetic for anyone who does not put in fresh money, and it matters for shareholders who care about control thresholds, blocking minorities, or index weights rather than pure economics.

Economic dilution

This is the question of whether value has been transferred away from existing holders. In a rights issue with tradable rights, the theoretical answer is no, because the EUR 1.00 right compensates the non-subscriber. In a discounted placement to new investors, the answer is yes, because there is no compensating instrument. That asymmetry is the real reason regulators and institutional shareholders insist on pre-emption for large raises.

EPS dilution

Earnings per share almost always falls after a rights issue, because the share count rises immediately while the earnings benefit of the proceeds arrives slowly and partially. If the EUR 980.0m of net proceeds in our example repays debt costing 5.0% pre-tax at a 25% tax rate, earnings rise by about EUR 36.8m, roughly 12%, against a 25% increase in share count. EPS falls from EUR 1.50 to about EUR 1.35, a dilution of around 10.2%.

Note that this is a different mechanism from the share count dilution created by options and convertibles, which is handled through the treasury stock method rather than by issuing shares for cash. If that distinction is unfamiliar, our explainer on basic versus diluted share count and the practice case on calculating diluted share count cover it properly. It is also distinct again from accretion and dilution in M&A, where the share count rises because shares are used as acquisition currency.

Rights issue versus placement versus accelerated bookbuild

Interviewers rarely stop at the calculation. The natural follow-up is why the company chose this route.

The deciding constraint is usually capacity rather than preference. With 200.0m shares outstanding and a 10% non-pre-emptive authority, a placement can issue at most 20.0m shares. At a realistic 5% discount to EUR 25.00, that raises about EUR 475.0m, less than half the EUR 1,000.0m required. The placement is not rejected because it is unfair, it is rejected because it cannot physically raise the money without convening a shareholder meeting, which destroys the only advantage it had, namely speed.

The same speed-versus-size logic runs through the rest of equity capital markets. It is why a convertible bond is attractive to issuers who want equity-like funding without immediate dilution, and why the IPO process is measured in months rather than days.

Why the size of the discount is a risk decision, not a valuation signal

Newcomers often read a 30% or 40% discount as management admitting the shares are overvalued. That reading is wrong, and saying so in an interview is a quick way to demonstrate genuine understanding.

Because TERP mechanically adjusts to whatever subscription price is chosen, the discount does not transfer value away from a shareholder who subscribes or sells. A deeper discount simply means more shares at a lower price, a lower TERP, and a higher right value, and those effects offset. What the discount buys is execution certainty. The further the subscription price sits below the expected trading price, the further the share price would have to fall during the subscription period before subscribing became irrational and the underwriters were left holding stock. That is why rescue rights issues by companies in distress are almost always deeply discounted, and why the underwriting fee on a deeply discounted issue is lower.

The one group genuinely hurt by a deep discount is passive shareholders who neither subscribe nor sell, because the value they forfeit is larger. This is why deeply discounted issues attract governance criticism even though they are, on paper, value-neutral.

What a rights issue signals about the company

The structure is neutral, but the reason for the raise is not. Three broad situations recur:

• Deleveraging. Proceeds repay debt, leverage falls, the cost of equity should follow, and EPS dilutes. Common after a debt-funded acquisition disappoints or when covenants tighten. The credit angle here overlaps with the analysis in our case on high yield versus investment grade credit.
• Funding growth or an acquisition. Proceeds buy assets or a target. Whether the deal is accretive depends on whether the acquired earnings yield beats the earnings yield the new shares must carry, which is the same test applied in accretion and dilution analysis.
• Rescue. The company needs equity to survive. Discounts are deep, ratios are large, and existing holders who cannot follow their money are heavily diluted in ownership terms even if the theory says they are compensated.

Market reaction tends to track that reason far more than the terms. Announcing a rights issue to fund a well-argued acquisition frequently sees the shares hold up; announcing one to plug a hole rarely does.

How this comes up in interviews

The most common opening question is simply to calculate TERP from a set of terms, which takes thirty seconds once the formula is secure. The differentiating follow-ups are almost always conceptual: does the shareholder lose money, why not just do a placement, why is the discount so deep, and what happens to EPS. A candidate who can move fluently between the arithmetic and the intuition will handle all four.

It is worth being precise about one final convention. The discount quoted in a press release is the discount to TERP, not to the last close. In the example, that is 16.7% rather than 20.0%. Quoting the larger number overstates the concession the company made and is one of the fastest ways to reveal that the mechanics have not fully landed. Broader valuation context, including where equity issuance sits alongside the three core valuation methods, is covered across the rest of the valuation track.

Key takeaways

• A rights issue offers new shares pro rata to existing shareholders at a discount, with tradable pre-emption rights.
• TERP is the weighted average of old shares at the old price and new shares at the subscription price, and it is computed on gross proceeds.
• The value of one right equals the cum-rights price minus TERP, which also equals the per-new-share discount divided by the subscription ratio.
• Ownership dilution is unavoidable for non-participants, economic dilution is not, and EPS dilution is usually unavoidable when proceeds repay debt.
• The discount is chosen to reduce execution risk, not to signal a view on value.
• Placements are faster but constrained by non-pre-emptive authority, which is why large raises are structured as rights issues.

To turn the theory into a numerical answer you can deliver under pressure, work through the full rights issue case study covering TERP, right value, EPS dilution and the placement comparison, then test the related mechanics in the dilution deep dive.