Standby Underwriting
What Is Standby Underwriting?
Standby underwriting is a type of agreement to sell shares in a initial public offering (IPO) in which the underwriting investment bank consents to purchase anything that shares stay after it has sold every one of the shares it can to the public. In a standby agreement, the underwriter consents to purchase any leftover shares at the subscription price, which is generally lower than the securities exchange's price.
This underwriting method guarantees the responsible company that the IPO will collect a certain amount of money.
Grasping Standby Underwriting
Albeit the ability to buy shares below the market price might give off an impression of being an advantage of standby underwriting, the way that there are shares left over for the underwriter to purchase shows a lack of demand for the offering. Standby underwriting in this way transfers risk from the company that is opening up to the world (the issuer) to the investment bank (the underwriter). Due to this extra risk, the underwriter's fee might be higher.
Different options for underwriting an IPO incorporate a firm commitment and a best efforts agreement.
Standby versus Firm Commitment Underwriting
In a firm commitment, the underwriting investment bank gives a guarantee to purchase all securities being offered to the market by the issuer, whether or not it can sell the shares to investors. Giving companies incline toward firm commitment underwriting agreements over standby underwriting agreements — and all others — on the grounds that it guarantees all the money right away.
Regularly, an underwriter will consent to a firm commitment underwriting provided that the IPO is in high demand since it shoulders the risk alone; it requires the underwriter to put its own money at risk. On the off chance that it can't sell securities to investors, it should figure out how to manage the leftover shares — hold them and hope for increased demand or conceivably try to dump them at a discount, booking a loss on the shares.
The underwriter in a firm commitment underwriting will frequently demand a market out clause that would free them from the commitment to purchase every one of the securities in case of an event that corrupts the quality of the securities. Poor market conditions are commonly not among the acceptable reasons, but rather material changes in the company's business, in the event that the market hits a soft patch, or weak performance of different IPOs are in some cases reasons underwriters summon the market out clause.
Standby versus Best Efforts Underwriting
In a best efforts underwriting, the underwriters will put forth a valiant effort to sell every one of the securities being offered, however the underwriter isn't committed to purchase every one of the securities for any reason. This type of underwriting agreement will commonly become possibly the most important factor in the event that the demand for an offering is expected to be lackluster. Under this type of agreement, any unsold securities will be returned to the issuer.
As the name recommends, the underwriter essentially vows to put forth their best attempt to sell shares. The arrangement diminishes the risk to the underwriter since they are not responsible for any unsold shares. The underwriter can likewise cancel the issue by and large. The underwriter gets a flat fee for its services, which it will relinquish in the event that it selects to cancel the issue.
Highlights
- Different types of underwriting agreements incorporate best efforts and firm commitment.
- A standby underwriting agreement specifies that after an IPO, an investment bank will buy remaining shares that poor person been purchased by the public.
- A best efforts agreement basically says that the bank will put forth a valiant effort to sell to the public, yet it has no commitments to buy shares past that.
- In a firm commitment underwriting, the investment bank commits to buying shares, whether or not or not it can sell to the public.
