6.1.1. Types of Underwriting Commitments
To sell shares to the public, the company typically engages an investment bank, also called an underwriter. The underwriter will help the company register the securities, but perhaps more importantly, it will help market and sell the securities to the public and, in most cases, assume the risk of any unsold securities. The underwriter will typically be chosen by its reputation. It may be a large investment bank that has underwritten many public offerings in the past, or it may be a “boutique” investment bank that specializes in a particular industry. If the issuer chooses the underwriter and negotiates the terms of the contract with only this underwriter, it is called a negotiated offering. Negotiated offerings are the most common type of corporate underwritings. In contrast, when an issuer solicits bids for the offering and chooses an underwriter based on the lowest cost to the issuer, it is called a competitive offering. This type of offering is common for municipal security offerings but rare for corporate offerings.
Once an underwriter has been chosen, the issuer and underwriter will enter into an agreement that defines 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. In most cases, the investment bank will enter into what is called a firm commitment underwriting with the issuer of the securities. A firm commitment is an agreement that the underwriter will purchase all the securities at a discount and then sell the securities to the public at a 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. This is the most common type of underwriting commitment for a corporate offering, and it is preferred by most issuers.
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