An offering to your current shareholders may be your best source of funds

Would you throw good money after bad? That's often the question at the heart of a versatile but little-used money-raising technique called a rights offering. Profitable companies can usually attract new investors. But companies that are down on their luck often can't. For them a rights offering, which offers a company's shareholders the right to buy more stock at a preestablished price, may be the best bet for raising needed capital.

If your company has been losing money, your investors are probably disillusioned. Worse, they may be holding stock certificates worth only a fraction of what they paid for them. And a rights offering will further dilute the value of those shares. On the other hand, your shareholders once believed in your company. If you've tackled its problems, you may be able to reignite that belief. For an investor, it can be a seductive argument: instead of selling the stock and taking a hated loss, he or she can buy more shares at a cheaper price and bring down the average cost.

A rights offering can do more than raise money. For companies that are enlarging a shareholder's position, rights offerings provide a way to make sure no one feels cheated; when every shareholder has a chance to buy stock on the same terms, the company can't be accused of offering a sweetheart deal to the major stockholder.

That, in part, was Sam Metzger's motivation in offering his 500-plus shareholders a chance to buy more shares in Chipwich Inc. There's no question that he also needed the money. Chipwich, founded in 1980, achieved remarkable fame because of its product -- ice cream sandwiched between two chocolate-chip cookies and rolled in chocolate chips. Sold from snappy-looking pushcarts, Chipwich ice-cream sandwiches were wildly popular. The business overexpanded, expenses soared, and in 1984 three Chip-wich creditors forced the company into bankruptcy.

By 1987 Metzger, who cofounded Chipwich with Richard LaMotta, had slogged through the company's reorganization and found a new lease on life in the form of Hexagon AB, a Swedish holding company that agreed to invest $1 million in Chipwich, guarantee loans, and license its products. But as Chipwich began to grow again, it faced two problems.

The first was money. Like any ambitious company, it needed more. Unlike other companies, though, it had few options. Being an ex-bankrupt company doesn't have the stigma it used to -- but banks still don't line up to see you.

The second problem was an odd one. Metzger and his lawyers had been lucky enough to get all of Chipwich's unsecured creditors to cancel the company's debt obligations in return for a small cash payment and equity. That, of course, turned the creditors into shareholders. The exchange also required Chipwich to begin filing reports with the Securities and Exchange Commission. Once it did, Chipwich would effectively become a public company because its shares could be sold in the open market.

The problem? Metzger wanted a stable stock price and an orderly market. No one knew how much a Chipwich share was worth or what the creditors would do with their shares once they could get rid of them. By issuing rights, Metzger hoped to establish a price for the stock and raise money. Here's the offer he made:

Chipwich shareholders received the right to buy one share of common stock for every two shares they owned. Shareholders had about 45 days to exercise their rights. For each share, holders had to surrender one right and pay $1. No partial subscriptions were allowed -- it was all or nothing. Nor could shareholders sell their rights, a feature of some such offerings.

The key figure here is the buck that Chipwich was asking shareholders to pay for each new share. Because Chipwich had only marginal income, Metzger had to try to assess the value of Chipwich's name brand. Also influencing the price: Chipwich's prior sale of 600,000 shares to Hexagon for $1 per share. The valuation was cobbled together out of such subjective data that Chipwich's prospectus says right up-front: "The offering price has been arbitrarily determined by the Company."

The chief drawback of a rights offering is that you don't know if it will work; that is, how many shareholders will bite and how much cash it will raise. That's why some companies hire an underwriter as a backup to sell those shares that no one subscribes for. But Chipwich had designed its rights offering around its own backup -- Hexagon.

Hexagon was entitled -- and agreed -- to purchase 949,922 shares of the 1,924,815 shares being offered through the rights offering. It also told Chipwich it would buy any shares that were left over at the end of the subscription period by exercising its oversubscription privilege.

Hexagon took the biggest share of the offering; Metzger and LaMotta exercised their rights, too. What was surprising was that some 45 other shareholders, mostly former creditors, also subscribed. "To be a creditor usually leaves a bad taste in one's mouth," says Chipwich treasurer Robert Doria. After all rights were exercised, Chipwich's rights offering raised just over $2 million.

Expenses were negligible. The SEC required Chipwich to file an S-18, but that was easy. The company's plan of reorganization, drawn up while it was in Chapter 11, contained most of the necessary financial and historical information. Total expenses, mainly legal and auditing fees, came to $120,000.

Aside from the all-important cash, Chipwich's rights offering established a stock price that has held up reasonably well in subsequent trading. Since the offering in February 1987, the stock has traded as high as $2 and as low as 56¢. During the first half of this year, it has hovered around $1.25 per share.

But even an apparently successful rights offering doesn't always work out the way you expect. Metzger thought the offering had firmly cemented the company to a powerful protector -- Hexagon. Last winter, however, it discovered that Munksjo AB, a Swedish forestry company, had bought a controlling interest in Hexagon. Now Metzger will discover just how far Chipwich's rights will go.


To make a rights offering work for you, design it carefully

A rights offering can serve all kinds of purposes, depending on how it's structured. Everything depends on the price you assign to the shares. Too high, and no one will subscribe to the offering; too low, and you're leaving money on the table. But set the price only after you have taken these two important factors into account:

* Transferability. If you make the rights transferable and price them shrewdly, control of the company could be up for grabs. Shareholders who don't want more stock can sell to shareholders who do. This feature makes a rights offering more expensive, because you must arrange for a brokerage firm to maintain an orderly market for the subscription period.

* Backup buyer. If you don't have a backup buyer, you risk the chance of raising less money than you had planned. If you need to be sure of how much cash you'll get, you can hire an underwriter to sell the leftover shares. Or you may have a major shareholder, as Chipwich did, who's willing to act as a backup.