What Is a Back Stop?
Let me explain what a back stop is in the world of corporate finance and investment banking. It's essentially a financial arrangement where someone like an underwriter or a major shareholder steps in to buy any shares that don't get subscribed in a securities offering. This ensures you, as the issuer, raise the capital you need without fail.
When you're a company looking to bring in money through issuing securities and you want a guarantee on the amount, you can secure a back stop from an underwriter or a big shareholder—think investment banks. They'll commit to purchasing whatever portion remains unsubscribed.
Key Takeaways
Here's what you need to grasp: A back stop is about providing that final layer of support for the unsubscribed shares in an offering. If you're raising capital via issuance, getting this from an underwriter or major player means they'll buy what's left unsold. It works like insurance for the offering, making sure it doesn't flop if not all shares are taken by the market.
How a Back Stop Works
Think of a back stop as a safety net, similar to insurance but not literally a policy. If you're issuing securities and worry the market won't buy everything, you can arrange for certain organizations—usually investment banks—to guarantee they'll purchase a set amount if parts go unsold.
If it's an investment bank providing this, their sub-underwriters will sign a firm-commitment underwriting deal with you. This contract means they're on the hook to buy a specific number of unsold shares, giving you full support for the offering.
By signing this, the organization takes complete responsibility for those shares if they're not sold initially, and they provide the capital in return. This assures you that you'll hit your minimum capital target no matter what the market does, and it shifts all the risk of those shares to them.
But if the entire offering sells out through regular channels, the contract becomes irrelevant since the conditions for their purchase no longer apply.
Fast Fact
You should know that these contracts between you as the issuer and the underwriting group can vary. For instance, they might offer a revolving credit loan to improve your credit ratings, or issue letters of credit as guarantees for your capital-raising efforts.
Special Considerations
If the underwriting organization ends up with shares as per the agreement, those shares are theirs to handle however they want. You can't restrict how they trade them; they're just like any other investment they buy on the market.
They can hold or sell these securities following the usual regulations that apply to such activities.
Example of a Back Stop
Take a rights offering as an example. You might see something like: 'ABC Company will provide a 100 percent back stop of up to $100 million for any unsubscribed portion of the XYZ Company rights offering.' So if XYZ aims for $200 million but only gets $100 million from investors, ABC buys the rest.
What Is a Back Stop in a Bond Issue?
It's similar for bonds. A back stop here is a guarantee where the underwriting bank or syndicate sets a price to buy any unsold or unsubscribed bonds, ensuring the issue succeeds.
Who Are Backstop Purchasers?
If the main underwriters can't or won't handle the back stop, you might bring in third-party backstop purchasers. They'll buy the unsubscribed parts, often at a lower price or with fees, and then aim to sell them off profitably over time.
What Are Volcker Rule Backstop Provisions?
The Volcker Rule separates commercial and investment banking to avoid conflicts and unfair practices. One key part prevents an underwriting bank from backstopping an issue if it creates a conflict. It's also banned if it exposes the bank to high-risk assets or strategies, or threatens the bank's safety or U.S. financial stability.
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