Business Finance · Financial instruments issued or used by companies

Ordinary Shares and Equity Financing: Features, IPOs and Rights Issues

Updated 11 October 2026 · Fact-checked

Ordinary shares are the residual ownership claim on a company. Holders get votes and dividends only after creditors and preference shareholders are paid. Companies raise equity through an IPO, a rights issue to existing holders, or a placing with selected investors. To solve questions, identify the issue type, then compute price, shares and dilution.

Understand Ordinary Shares and Equity Financing

An ordinary share (called an equity share in India) is a unit of ownership in a company. Ordinary shareholders are the owners. They bear the most risk, so they expect the highest return over the long term.

The key features are these:
- Residual claim: dividends are paid only if the board declares them, and only after interest and any preference dividends.
- Last in line on winding up: creditors and preference shareholders are paid first. Ordinary holders get what is left, which may be nothing.
- Voting rights: holders usually vote on directors and major decisions, so they have control.
- Limited liability: you can lose only the amount you paid or agreed to pay for the shares.
- No fixed return and no maturity date: returns come from dividends and capital gains.

Compared with preference shares, ordinary shares carry no fixed dividend, rank lower, and normally carry full votes. Compared with debt, they carry no obligation to pay, and the company has no repayment date. This makes equity safer for the company but more costly, because investors need a higher return for the higher risk. Dividends are also paid out of taxed profit, while interest is normally a tax-deductible expense.

Companies raise new equity in three main ways. In an IPO (initial public offering), a private company sells shares to the public for the first time and gets listed. In a rights issue, existing shareholders are offered new shares in proportion to their holding, usually at a discount to market price. In a placing, new shares are sold directly to a small group of institutional investors. Placings are quicker and cheaper but do not offer shares to all existing holders first.

A rights issue protects existing holders from dilution of control. If they do not want to buy, they can sell their rights. The share price falls after the issue because of the extra shares at a lower price. The theoretical ex-rights price captures this.

Key rules to remember

Theoretical ex-rights price (TERP): TERP = (N × P + n × S) ÷ (N + n); N = old shares held, P = cum-rights price, n = new shares taken for those N, S = subscription price. This is the weighted average price after the issue.
Value of a right (per old share): Value of right per new share = TERP − S; Per old share, multiply by the ratio of new to old shares. Assumes the market price falls to TERP.
Funds raised: Gross proceeds = number of new shares × issue price; Net proceeds = gross proceeds − issue costs.
Rights ratio: Ratio = new shares : old shares; For example, 1 for 4 means 1 new share for every 4 held.
Earnings per share: EPS = earnings attributable to ordinary shareholders ÷ number of ordinary shares; Earnings are after interest, tax and preference dividends.

How to solve Ordinary Shares and Equity Financing questions

Use this order for any question on ordinary shares or equity issues.

1Read the question and identify what is asked: features, a method of raising equity, or a calculation.
2For descriptions, list rights, risks, and compare with debt or preference shares, as the question requires.
3For an issue, name the method: IPO, rights issue or placing. State who can buy and at what price.
4For a rights issue, write down N, P, n and S from the question. Check the ratio carefully.
5Compute the number of new shares, proceeds, and TERP using the weighted average.
6Compute the value of a right or the effect on a holder's wealth if asked. Compare taking up, selling or ignoring rights.
7State the assumptions, such as no change in company value apart from the cash raised, and give costs or tax effects if relevant.
8Finish with a short conclusion that answers the question in words.

Quickest way: Fast rights issue calculation

When to use it: Use this for MCQs or short calculations on a rights issue when the ratio and prices are given.

Take a block of shares equal to the denominator of the ratio, such as 4 old shares for a 1 for 4 issue.
Add the value of the old block at market price to the cash paid for the new shares.
Divide by the total shares in the block to get TERP.
Value of a right per new share is TERP minus subscription price.
Check that TERP lies between the subscription price and the cum-rights price.

Common mistakes in Ordinary Shares and Equity Financing

Treating ordinary shares as having a guaranteed dividend.
Students mix them up with preference shares or debt interest.
Fix: State that ordinary dividends are discretionary and paid after fixed claims. Only the residual belongs to them.
Saying a rights issue raises money at the market price.
Students forget the discount that makes the offer attractive.
Fix: Use the subscription price S, which is normally below market price, for the cash raised and in TERP.
Using the wrong weights in TERP.
The ratio 1 for 4 gets read as 1 new plus 4 old with the wrong total.
Fix: Write the block: 4 old shares at P plus 1 new at S, total 5 shares. Divide by 5.
Claiming a rights issue makes shareholders poorer.
Students see the fall in share price and stop there.
Fix: Compare total wealth. The holder has more shares at a lower price plus the cash paid. If rights are taken up or sold, wealth is unchanged, ignoring costs.
Confusing a placing with a public offer.
Both issue new shares, so the differences blur.
Fix: Say a placing is sold to selected investors only, is cheaper and quicker, but existing holders get no priority unless there is a clawback.
Forgetting issue costs when asked for net funds or cost of equity.
The question gives costs in a small line.
Fix: Subtract costs from gross proceeds. Underwriting and legal fees reduce the cash the company keeps.

Worked examples

Example 1

A company has 8,00,000 ordinary shares in issue at a market price of ₹150. It makes a 1 for 4 rights issue at ₹110 per share. Ignoring issue costs, calculate (a) the funds raised, (b) the theoretical ex-rights price and (c) the value of a right per old share.

Show the solution

New shares = 8,00,000 ÷ 4 = 2,00,000.
Funds raised = 2,00,000 × ₹110 = ₹2,20,00,000.
TERP: block of 4 old at ₹150 = ₹600 plus 1 new at ₹110 = ₹710. Total 5 shares.
TERP = 710 ÷ 5 = ₹142.
Value of a right per new share = 142 − 110 = ₹32.
Per old share, the right covers 1/4 of a new share: 32 ÷ 4 = ₹8.

Answer: (a) ₹2,20,00,000; (b) TERP = ₹142; (c) value of a right = ₹8 per old share (₹32 per new share).

Example 2

An investor holds 1,000 shares in the company above. Show that she is equally well off whether she takes up her rights or sells them, ignoring costs and tax.

Show the solution

Before the issue: 1,000 × ₹150 = ₹1,50,000.
Option 1, take up: she buys 250 new shares at ₹110 = ₹27,500.
She then holds 1,250 shares at TERP ₹142 = ₹1,77,500.
Net wealth = 1,77,500 − 27,500 = ₹1,50,000.
Option 2, sell rights: she keeps 1,000 shares at ₹142 = ₹1,42,000.
She sells 250 rights at ₹32 = ₹8,000.
Total wealth = 1,42,000 + 8,000 = ₹1,50,000.

Answer: Both options leave her with ₹1,50,000, the same as before the issue. A rights issue at a discount does not by itself reduce wealth if she acts on her rights.

Exam tips

Show the block method for TERP. Examiners give marks for the working even if the arithmetic slips.
In discussion questions, structure answers by rights, risks, cost and control. Compare with debt or preference shares when the question hints at it.
For IPO versus rights issue, cover cost, speed, control, pricing and who the buyers are.
Check that the answer is sensible. TERP must sit between S and P.
Use the stated assumptions, such as no change in firm value or no transaction costs, and write them down.

Practice questions from Financial instruments issued or used by companies

Ordinary Shares and Equity Financing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

ACCA Applied KnowledgeShare Capital: Ordinary and Preference Shares

Ordinary Shares and Equity Financing: frequently asked questions

What is the difference between ordinary shares and preference shares?

Ordinary shares carry the residual claim, normal voting rights and variable dividends. Preference shares usually carry a fixed dividend and rank ahead of ordinary shares for dividends and on winding up, but often have limited or no votes.

How is a rights issue different from an IPO?

A rights issue offers new shares to existing shareholders in proportion to their holding, usually at a discount. An IPO sells shares to the public for the first time and lists the company. A rights issue is cheaper and keeps control with existing holders.

Why are rights issues priced at a discount?

The discount makes it likely that shareholders will take up the offer, so the issue succeeds. Because holders receive the rights in proportion to their holdings, the discount does not by itself transfer value away from them.

Why is equity more expensive than debt for a company?

Equity holders bear more risk, since they are paid last, so they need a higher expected return. Dividends also do not usually give tax relief, while interest normally does. Issue costs for equity can also be higher.