What Does an Underwriter Do?

Underwriters are financial institutions that play a crucial role in bringing securities to market, whether through initial public offerings (IPOs), debt issuances, or other capital-raising activities. They serve as intermediaries between companies seeking capital and investors looking for investment opportunities, managing the complex process of pricing, marketing, and distributing securities. Understanding the role of underwriters is essential for companies considering public offerings and investors participating in capital markets.

What Is an Underwriter?

An underwriter is a financial institution, typically an investment bank, that helps companies and other entities raise capital by issuing and selling securities. Underwriters assume financial risk by agreeing to purchase securities from issuers and then reselling them to investors, essentially guaranteeing that the issuer will receive the intended capital.

Primary Functions

Risk Assessment: Evaluating the financial health and prospects of the issuing company
Pricing: Determining the appropriate price for the securities being offered
Marketing: Promoting the offering to institutional and retail investors
Distribution: Managing the sale and allocation of securities to investors
Stabilization: Supporting the security's price in the immediate post-offering period

Types of Underwritten Securities

Common Underwritten Offerings

Initial Public Offerings (IPOs)
Follow-on equity offerings
Corporate bond issuances
Convertible securities
SPAC IPOs and business combinations
Municipal bonds

The Underwriting Process

Pre-Marketing Phase

Due Diligence: Comprehensive review of company financials, operations, and prospects
Registration Statement: Preparation of SEC filing documents (S-1 for IPOs)
Legal Review: Coordination with legal counsel on disclosure and compliance
Financial Modeling: Analysis of company valuation and comparable transactions
Syndicate Formation: Assembly of underwriting syndicate for larger offerings

Marketing and Roadshow

Investor Presentations: Creation of pitch materials and management presentations
Roadshow Management: Organizing meetings with institutional investors
Book Building: Collecting indications of interest from potential investors
Price Discovery: Gauging investor demand to inform final pricing
Media Relations: Managing public communications and analyst coverage

Pricing and Allocation

Final Steps

Analyze book of investor demand
Set final offering price with issuer
Allocate shares among investors
Execute purchase agreement
Begin trading and aftermarket support

Types of Underwriting Arrangements

Firm Commitment Underwriting

Risk Assumption: Underwriter purchases entire offering from issuer
Price Guarantee: Issuer receives agreed-upon proceeds regardless of market reception
Resale Risk: Underwriter bears risk of not selling all securities
Most Common: Standard structure for most public offerings

Best Efforts Underwriting

No Purchase: Underwriter does not buy securities from issuer
Sales Agent: Acts as agent to sell securities on behalf of issuer
No Guarantee: Issuer only receives proceeds from actual sales
Lower Risk: Underwriter has reduced financial exposure

All-or-None Underwriting

Contingent Deal: Offering only proceeds if entire issue is sold
Escrow Arrangement: Proceeds held in escrow until full subscription
Refund Provision: Investors refunded if offering is not completed
High Threshold: Used when minimum proceeds are essential

Standby Underwriting

Rights Offerings

Used in rights offerings to existing shareholders
Underwriter commits to purchase unsubscribed shares
Ensures company receives full proceeds
Common in international markets

Underwriter Compensation

Underwriting Spread

The primary compensation for underwriters is the underwriting spread - the difference between the price paid to the issuer and the public offering price:

Management Fee: 10-20% of spread for lead underwriter's management
Underwriting Fee: 60-70% of spread for risk assumption
Selling Concession: 50-60% of spread for distribution efforts
Typical Range: 3-7% of offering proceeds for IPOs

Additional Fees

Advisory Fees: Separate fees for strategic advice and positioning
Expense Reimbursement: Issuer covers due diligence and legal costs
Over-allotment Options: Additional fees from greenshoe exercises
Warrant Coverage: Warrants provided as additional compensation

Fee Structure Example

$100M IPO Example

Public Offering Price: $20.00 per share
Underwriter Purchase Price: $18.60 per share
Underwriting Spread: $1.40 per share (7%)
Total Underwriter Compensation: $7M
Net Proceeds to Company: $93M

Underwriting Syndicate Structure

Lead Underwriter (Book Runner)

Primary Role: Manages the entire offering process
Largest Allocation: Typically 15-40% of the offering
Decision Authority: Makes final decisions on pricing and allocation
Regulatory Responsibility: Primary interface with regulators

Co-Lead Managers

Shared Responsibility: Assist with marketing and distribution
Significant Allocation: 10-25% allocation each
Investor Access: Bring their institutional investor relationships
Regional Coverage: May provide geographic or sector expertise

Syndicate Members

Distribution Focus: Primarily responsible for selling to their clients
Smaller Allocations: 1-10% of offering typically
Specialized Reach: Access to specific investor bases
Lower Commitment: Reduced financial and reputational risk

Selling Group

Extended Distribution

Brokers who sell but don't underwrite
Receive selling concession only
No financial commitment to purchase
Helps broaden distribution reach

Risk Management and Due Diligence

Financial Analysis

Historical Performance: Review of past financial statements and trends
Business Model: Analysis of revenue sources and profitability drivers
Market Position: Competitive analysis and market share assessment
Growth Prospects: Evaluation of future business opportunities

Legal and Regulatory Review

Disclosure Compliance: Ensuring adequate disclosure of material information
Legal Issues: Identifying potential litigation or regulatory risks
Corporate Structure: Review of ownership and governance structures
Intellectual Property: Assessment of IP assets and potential infringement

Market Conditions Assessment

Timing Considerations

Overall market sentiment and volatility
Sector-specific investor appetite
Comparable company performance
Economic and political conditions
Calendar of competing offerings

Post-Offering Responsibilities

Price Stabilization

Aftermarket Support: Buying shares to support price if needed
Over-allotment Option: Using greenshoe to manage supply/demand
Penalty Bids: Reclaiming selling concessions from flippers
Time Limits: Stabilization limited to 30 days typically

Research Coverage

Analyst Initiation: Beginning research coverage post-offering
Quiet Period: Restrictions during regulatory quiet periods
Ongoing Coverage: Regular research reports and investor updates
Conflict Management: Managing conflicts between banking and research

Ongoing Relationship

Follow-on Offerings: Potential for future capital raising mandates
M&A Advisory: Strategic advice on mergers and acquisitions
Market Making: Providing liquidity in secondary trading
Corporate Access: Facilitating investor meetings and conferences

Selecting an Underwriter

Key Selection Criteria

Track Record: Success with similar companies and transactions
Distribution Capability: Quality and breadth of investor relationships
Sector Expertise: Understanding of company's industry and business model
Research Quality: Strength of equity research and analyst coverage
Fee Structure: Competitive pricing and fee arrangements

Beauty Contest Process

Underwriter Selection Steps

Initial Presentations: Banks pitch their capabilities and approach
Detailed Proposals: Comprehensive proposals with valuation ranges
Reference Checks: Speaking with other companies and investors
Chemistry Assessment: Evaluating working relationship potential
Final Selection: Choosing lead and syndicate members

Negotiation Points

Fee Structure: Underwriting spread and additional fees
Syndicate Allocation: Size and composition of underwriting group
Marketing Strategy: Approach to investor marketing and roadshow
Research Commitment: Analyst coverage and research quality
Aftermarket Support: Commitment to price stabilization and support

Regulatory Environment

SEC Oversight

Registration Requirements: Filing and approval of registration statements
Disclosure Standards: Ensuring adequate investor disclosure
Selling Restrictions: Rules governing marketing and sales activities
Cooling-off Periods: Mandatory waiting periods before effectiveness

Industry Regulations

FINRA Rules: Self-regulatory organization oversight
Capital Requirements: Minimum capital and net capital rules
Conflict Management: Chinese walls and conflict of interest policies
Customer Protection: Suitability and best execution requirements

Conclusion

Underwriters play a vital role in capital markets by facilitating the flow of capital from investors to companies and other issuers. Their expertise in pricing, marketing, and risk management helps ensure successful capital raising while providing important protections for both issuers and investors.

For companies considering public offerings, selecting the right underwriter is crucial for achieving optimal results. The underwriter's reputation, capabilities, and commitment can significantly impact the success of an offering and the company's ongoing relationship with public markets.

Understanding the underwriting process helps all market participants - from companies seeking capital to investors evaluating opportunities - make more informed decisions and better navigate the complexities of public markets.