Types of Underwriting Commitments
Once chosen, the lead underwriter will enter into an agreement with the issuer that will define who will bear most of the responsibility for selling and marketing the shares, as well as who will take on the financial risk of any unsold shares. The underwriter’s agreement may take various forms.
Firm commitment underwriting. In most traditional stock and bond offerings, an investment bank will enter into a firm commitment underwriting with the issuer of the securities. A firm commitment underwriting is an agreement that the underwriter will purchase all the securities at a discount and then sell the securities to the public at a fixed public offering price. In this type of agreement, the underwriter is responsible for the marketing and sale of the securities and assumes all the risk of the offering, including the liability of any unsold shares. The offering is conducted in a single day.
Firm commitment underwritings may be undertaken in one of two ways. In a competitive bidding process, the company solicits underwriters to submit a sealed bid for the underwriting contract. The issuer awards the contract to the underwriter with the most competitive price and contract terms. With a negotiated bid, the company elects to negotiate with a single underwriter for the contract.
Best-Efforts Underwriting. Smaller companies most likely will engage in a best-efforts commitment with its underwriter. In this kind of agreement, the underwriter agrees to use its best efforts to sell the issuer’s securities, but the underwriter does not guarantee that all the shares will be sold. Nor is the underwriter financially responsible for the securities it doesn’t