What Is an Underwriting Agreement?
Let me explain what an underwriting agreement is—it's a contract between a group of investment bankers forming an underwriting group or syndicate and the corporation issuing new securities.
Key Takeaways
You need to know that this agreement happens between the syndicate of investment bankers and the issuing corporation for a new securities issue. It makes sure everyone understands their roles to avoid conflicts. The contract spells out the underwriting group's commitment to buy the securities, the price they've agreed on, the starting resale price, and the settlement date. You'll find different structures like best efforts and firm commitment, among others.
Understanding Underwriting Agreements
The main goal of the underwriting agreement is to clarify responsibilities for all involved, reducing potential disputes. You can also call it an underwriting contract. Essentially, it's the deal between the corporation putting out new securities and the underwriting group that buys and resells them for profit. As I mentioned, this involves the issuing corporation and investment bankers who team up in a syndicate—a temporary group handling big transactions that are too much for one alone. The agreement covers transaction details, including the group's promise to purchase the securities, the set price, initial resale price, and settlement date.
Keep in mind that a best-efforts underwriting agreement is typically used for high-risk securities sales.
Types of Underwriting Agreements
There are various kinds of underwriting agreements you should be aware of, including firm commitment, best efforts, mini-maxi, all or none, and standby.
Details on Each Type
- Firm Commitment: Here, the underwriter guarantees to buy all offered securities from the issuer, even if they can't sell them to investors—it's the top choice because it delivers the issuer's money immediately, especially for high-demand offerings, but it risks the underwriter's money, so they often add a market out clause to escape if something damages the securities' quality, like a regulatory denial, though poor market conditions don't count.
- Best Efforts: In this setup, underwriters try their hardest to sell all securities but aren't required to buy them themselves—if demand is low, unsold shares go back to the issuer.
- Mini-Maxi: This is a best-efforts type that only activates once a minimum number of securities is sold, allowing sales up to a maximum, with funds in escrow until completion—if the minimum isn't met, the offering cancels and money returns to investors.
- All or None: The issuer insists on selling every security to get the proceeds, holding funds in escrow until all are sold—if not, the whole thing cancels and funds return.
- Standby Underwriting: Used with preemptive rights offerings on a firm commitment basis, where the underwriter buys any shares not taken by current shareholders and resells them publicly.
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