What is an underwriting agreement?
An underwriting agreement is an agreement between a group of investment bankers who form an underwriting group or syndicate and the company issuing a new issue of securities.
The purpose of the underwriting agreement is to ensure that all actors understand their responsibility in the process, thus minimizing potential conflicts. The underwriting agreement is also called an underwriting agreement.
Key points
- An underwriting agreement is entered into between a syndicate of investment bankers forming an underwriting group and the company issuing a new issue of securities.
- The agreement ensures that everyone involved understands their responsibilities in the process.
- The contract outlines the underwriting group’s commitment to purchase the new issue of securities, the agreed price, the initial resale price, and the settlement date.
Understanding Underwriting Agreements
The insurance underwriting agreement can be viewed as the agreement between a company that issues a new issue of securities and the underwriting group that agrees to buy and resell the issue for profit.
As mentioned above, the contract is generally between the company issuing the new bond and the investment banks that form a syndicate. A union is a temporary group of financial professionals formed to handle a large financial transaction that would be difficult to manage individually.
The subscription agreement contains the details of the transaction, including the subscription group’s commitment to purchase the new issue of securities, the agreed price, the initial resale price, and the settlement date.
There are several types of underwriting agreements: the firm commitment agreement, the best commitment agreement, the mini-maxi agreement, the all or nothing agreement, and the standby agreement.
Types of underwriting agreements
In a firm commitment subscription, the subscriber guarantees to purchase all securities offered for sale by the issuer regardless of whether they can sell them to investors. It is the most desirable deal because it guarantees all of the issuer’s money right away. The more requested the offer, the more likely it is to be made on a firm commitment basis. With a firm commitment, the underwriter puts his money at risk if he cannot sell the securities to investors.
Underwriting an offering of securities on the basis of a firm commitment exposes the subscriber to substantial risk. Therefore, underwriters often insist on including a market out clause in the underwriting agreement. This clause releases the subscriber from the obligation to purchase all the securities in the event that a development occurs that compromises the quality of the securities. Bad market conditions, however, are not a qualifying condition. An example of when a market out clause could be invoked is if the issuer were a biotech company and the FDA had just denied the approval of the company’s new drug.
In an underwriting agreement with the best of efforts, the underwriters do their best to sell all securities offered by the issuer, but the underwriter is not obligated to purchase the securities for his own account. The lower the question of a problem, the greater the likelihood that it will be executed with maximum effort. Any shares or bonds in a better subscription that have not been sold will be returned to the issuer.
A best-effort underwriting agreement is primarily used in the sale of high-risk securities.
A mini-maxi deal is a type of maximum commitment underwriting that does not become effective until a minimum amount of securities are sold. Once the minimum is reached, the subscriber can then sell the securities up to the maximum amount specified in the terms of the offer. All funds raised by investors are held as collateral until the subscription is completed. If the minimum amount of securities specified in the offer cannot be reached, the offer is canceled and the investors’ funds are returned to them.
With an all-or-nothing subscription, the issuer determines that it must receive the proceeds from the sale of all securities. Investors’ funds are held as collateral until all securities are sold. If all securities are sold, the proceeds are released to the issuer. If all securities are not sold, the issue is canceled and the investors’ funds are returned to them.
A standby subscription agreement is used in conjunction with a preventive rights offering. All standby subscriptions are made on a firm commitment basis. The standby subscriber agrees to purchase any shares that the current shareholders do not purchase. The pending underwriter then resells the securities to the public.
