An issuer needs investors, distribution capacity and certainty about funding. An underwriting syndicate is a group of investment banks that distributes the offering and divides responsibilities. The lead manager coordinates execution; underwriting commitment types determine who bears the financial risk.
- Firm commitment: The underwriters purchase the agreed securities from the issuer for resale, subject to customary closing conditions.
- Best efforts: The investment bank acts as a selling agent without promising to purchase unsold securities. The issuer bears the risk of raising less money.
- All-or-none: The offering closes only if every security sells under the specified conditions. Otherwise, investors receive the promised refund. This is generally a contingent best efforts arrangement.
- Standby: The underwriter agrees to purchase shares left unsubscribed in a rights offering, where existing shareholders receive rights to buy additional shares.
DECISION: Ask who should carry any unsold securities. If the issuer needs funding certainty, use a firm commitment, since the underwriters buy the securities. If the issuer can accept raising less, use best efforts.
Common mistakes
- Treating best efforts as a purchase promise. Selling 80% leaves the issuer bearing the funding shortfall.
- Treating FINRA's 3% expense limit as the total spread cap. It governs non-accountable allowances.
- Applying a 180-day compensation-securities restriction to every shareholder. Read the shareholder lock-up agreement.
Bottom line
- Firm commitment places unsold-inventory risk on underwriters; best efforts leaves funding risk with the issuer.
- Gross spread equals management fee plus underwriting fee plus selling concession.
- Fixed-pot credits follow agreed percentages; jump-ball credits follow designations under the agreement.
- Rule 10b-9 governs contingent-offering refund promises; Rule 15c2-4 governs handling subscriber funds.
Exam shortcut
Circle whose money the question asks for: issuer proceeds, total spread, a member's underwriting fee or selling credit. Identify who supplies any option shares. For compensation, separate commitment percentage from selling allocation. Apply each percentage only to the fee component it controls. For a restriction question, identify the actor before using liquidity figures. An underwriter's exception may not protect the issuer.
The full lesson (about 3,951 words, 26 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- B16
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