What Is Gross Spread?
Let me explain what gross spread means in the context of an initial public offering, or IPO. When a private company goes public by issuing shares, the underwriters—typically investment banks—get compensated through the gross spread. This is simply the difference between the price the underwriters pay the issuing company for the shares and the price they offer those shares to the public. Think of it as the bank's cut or profit from facilitating the IPO. You might also hear it called gross underwriting spread, spread, or production.
Key Takeaways
Here's what you need to remember about gross spread. It's the main compensation for underwriters in an IPO. Most of the profits an underwriting firm makes from the deal come from this spread. The funds from the gross spread cover management and underwriting fees, plus sales concessions to broker-dealers.
Understanding the Gross Spread
The gross spread pays for the underwriting firm's work in handling an IPO. As I mentioned, it's where most of their profits come from. A company might pick multiple underwriters if they bring specialized expertise.
If a company wants to raise capital from investors, they'll hire an investment bank as the underwriter for the IPO. Together, the bank's underwriters and the company figure out how much money the IPO will raise and what the bank gets paid.
They file a registration statement with the Securities and Exchange Commission (SEC). The SEC reviews it, and once everything checks out, they set a date for the IPO.
The investment bank buys the shares to fund the IPO and then sells them to its network at a higher price. That difference is the gross spread—straightforward profit for the underwriter.
Gross Spread and Underwriting Costs
The money from the gross spread covers various underwriting costs, including the manager's fee and the underwriting fee earned by syndicate members. It also includes the concession, which is the spread earned by broker-dealers selling the shares.
The lead manager gets the full gross spread. Each syndicate member receives a share—possibly unequal—of the underwriting fee and concession. A broker-dealer outside the syndicate who sells shares only gets part of the concession, while the syndicate member providing those shares keeps the underwriting fee. This spread also handles legal and accounting expenses, plus registration fees.
As the total gross spread grows, the concession portion increases proportionally, while management and underwriting fees decrease. This happens because of economies of scale. The work to write the prospectus or prepare the roadshow is somewhat fixed, but sales efforts scale with deal size. Bigger deals don't always mean more banker work, but they do require more selling, so the concession rises. Junior banks might join syndicates for smaller shares, often via lower concessions.
Example of Gross Spread
Take Company ABC as an example. They receive $36 per share for their IPO. If the underwriters sell those shares to the public at $38 per share, the gross spread is $2 per share. Factors like issue size, risk, and market volatility can affect this value.
Gross Spread Ratio
You can express the gross spread as a ratio. In the example, the $2 difference divided by the $38 public price gives about 5.3% ($2 / $38). A higher ratio means more IPO proceeds go to the investment bank. Typically, this ratio ranges from 3-7%, depending on deal size and the country involved.
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