What Is an Underwriter Syndicate?
Let me tell you directly: an underwriter syndicate is a temporary group of investment banks and broker-dealers that comes together to sell new offerings of equity or debt securities to investors. I form and lead this syndicate as the lead underwriter for a security issue.
When an issue is too large for a single firm to handle, you see an underwriter syndicate formed so that the resources of all the firms can be used to orchestrate the issuance and spread out the risk. The syndicate gets compensated by the underwriting spread, which is the difference between the price paid to the issuer and the price received from investors and other broker-dealers when the issuance goes public.
You might also hear an underwriter syndicate referred to as an underwriting group, banking syndicate, or investment banking syndicate.
Key Takeaways
- An underwriter syndicate is a group of investment banks and broker-dealers formed temporarily to sell new issues of a company's equity or debt to investors.
- The reason for an underwriter syndicate is to pool the resources of multiple firms when an issue is too large for one firm to take on.
- An underwriter syndicate consists of a lead underwriter and the other participating members, where the risks of the underwriter role are spread across the syndicate.
- The lead underwriter receives the largest portion of the issue for disbursement as well as the responsibility of dealing with regulatory bodies.
- The profit or loss for the syndicate is determined by how the new stock performs on the market.
Understanding an Underwriter Syndicate
Under the firm commitment engagement, members of an underwriter syndicate are required to buy the shares from the company to sell to investors, as opposed to a company selling the shares directly to investors.
This removes a significant amount of risk for the issuing company as it is paid upfront for the shares by the syndicate and is, therefore, not concerned with having to sell the inventory of shares to investors; that risk is taken on by the underwriter syndicate. The risk that an underwriter syndicate takes on is mitigated, especially for the lead underwriter, by spreading the risk out among all the participants in the syndicate.
Since the underwriting syndicate has committed to selling the full issue, if demand for it is not as robust as anticipated, the syndicate participants may have to hold part of the issue in their own inventory, which exposes them to the risk of a price decline. In exchange for taking the lead role, the lead underwriter gets a larger proportion of the underwriting spread and other fees, while the other participants in the syndicate receive a smaller portion of the spread and fees.
Firm commitment may be compared to the best efforts underwriting, where the underwriter agrees to give their highest personal effort to sell as much as possible of the shares.
The Process of an Underwriter Syndicate
Members of an underwriter syndicate often sign an agreement that sets forth the allotment of the stock to each participant and the management fee, in addition to other rights and obligations.
The lead underwriter runs the syndicate and allocates shares to each member of the syndicate, which may not be equal among the syndicate members. The lead underwriter also determines the timing of the offering, as well as the offering price, and fulfills any requirements with regulatory issues with the Securities and Exchange Commission (SEC) or Financial Industry Regulatory Authority (FINRA).
In determining the offering price, the underwriter syndicate must obtain all the necessary financial information as well as determining the growth prospects of the firm. Typically, a closed bidding process amongst the syndicate members is held to arrive at the price of the initial public offering (IPO).
For popular initial public offerings, investors may exhibit a greater demand for shares than there are shares available. In this case, the IPO is oversubscribed. This kind of demand can only be met once shares begin actively trading on the exchange. This pent-up demand could lead to dramatic price swings during the first few days of trading.
As such, there is significant risk associated with individual investors participating in IPOs, either receiving shares as the client of an investment bank or by buying and selling shares once they begin trading.
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