What Is an Underwriting Agreement?
An underwriting agreement is a contract entered into between a group of investment bankers—forming an underwriting group or syndicate—and a corporation that is issuing new securities.
Key Takeaways
- An underwriting agreement is a contract between an underwriting group formed by investment bankers and the corporation issuing a new securities issue.
- It ensures all parties involved understand their responsibilities, thereby minimizing potential conflicts.
- The agreement outlines key transaction details: commitments to purchasing the new securities issue, the agreed price, the initial resale price, and the settlement date.
- Underwriting agreements can vary in structure and include arrangements such as firm commitment and best efforts.
Understanding Underwriting Agreement
The primary goal of an underwriting agreement is to clarify responsibilities, reduce conflicts, and set clear terms for the transaction. Often referred to as an underwriting contract, it serves as a blueprint for the roles and expectations of each party involved.
The agreement specifies details such as the commitment of the underwriting group to purchase the securities issue, the price at which they agree to buy and initially sell the securities, and the settlement date.
Typically, such agreements involve a syndicate—a temporary group of financial professionals formed to manage large financial transactions.
Types of Underwriting Agreements
Underwriting agreements vary to cater to different financial needs. Here’s an overview of common types:
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Firm Commitment: In a firm commitment underwriting, the underwriter agrees to purchase all the securities from the issuer and resell them. This type guarantees immediate payment to the issuer, placing the underwriter’s money at risk if the securities remain unsold. High-demand offerings are often done on a firm commitment basis.
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Best Efforts: Through a best-efforts agreement, underwriters aim to sell as many securities as possible without committing to buying any unsold securities. This type suits lower-demand issues and minimizes the underwriter’s risk.
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Mini-Maxi: This is a subtype of best efforts underwriting where the agreement becomes effective only if a minimum number of securities are sold. Securities are sold up to a specified maximum, with funds held in escrow until the process completes. If the minimum threshold isn’t met, the offering is canceled, and investors receive refunds.
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All or None: In an all-or-none agreement, all securities must be sold for the offering to succeed. Investors’ funds are held in escrow until all securities are sold. If not all securities are sold, the offering is canceled, and investors’ funds are returned.
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Standby Underwriting: Typically used with preemptive rights offerings, this firm commitment underwriting requires the underwriter to purchase shares not taken up by the current shareholders, then resell them to the public. All funds related to the offering are guaranteed in the case of standby underwriting.
Related Terms: syndicate, firm commitment, best efforts, mini-maxi underwriting, all or none underwriting, standby underwriting.