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Chapter 13. The Public Offering Process > The Underwriting Agreement

The Underwriting Agreement

The Standard Methods

The underwriting agreement is the agreement which regulates the relationship between the company (the seller of the shares) and the underwriter (which usually buys the shares). This is a complex agreement, the negotiations for which last several months, concurrently with the preparation of the registration statement. In the United States, there are two customary types of underwriting agreements:

  • Firm commitment offering— This is the common method in the United States, according to which the underwriter buys the securities from the company for a price lower than their price to the public, with the difference being the underwriting commission. In this case, the underwriter assumes the risk that investors who expressed an interest in buying the shares during the book building process will not follow through on their orders (which are not binding, as mentioned in the section on road show, until the registration statement is declared effective). However, such exposure only exists in practice in the three to five days between the signing of the underwriting agreement (which is the date on which the registration statement is declared effective) and the closing of the transaction, upon which the shares are transferred to the buyers. Even this exposure is limited because the underwriting agreement establishes the underwriter's right to cancel the agreement if any adverse change occurs in the condition of the company or the market. In practice, however, due to underwriters' reputation considerations, this clause is almost never exercised. The underwriter usually has also an option (green shoe) to buy additional shares (up to 15% of the offering) for 30 days after the closing, in order to meet demand for the share or sale positions it had created therein. In this respect it is important to mention that an underwriter is allowed to support the price of the share (but not to regulate it) shortly after the IPO in order to prevent it from dropping under the IPO price.

  • Best efforts offering— Under this method, the underwriters undertake to use their best efforts to sell the shares, but do not undertake to buy any shares which are not sold. The underwriters usually require an initial amount which is not reimbursed, and payment for sold shares. If the IPO fails, the company nevertheless has to pay the various consultants and does not get the initial payment back from the underwriters. In some cases, the IPO is cancelled if the underwriters do not sell the entire pre-determined amount (best efforts, all or none). This agreement is uncommon among companies which are able to choose a reputable underwriter, and use the firm commitment arrangement.


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