When it comes to financing, underwriting agreements play an essential role in helping companies raise capital. These agreements are legally binding contracts between a company and an underwriter, outlining the terms of a securities offering. Underwriting agreements can come in various forms, with each type having its unique characteristics and benefits. In this article, we`ll explore the four main types of underwriting agreements and their functions.
1. Firm Commitment Underwriting
A firm commitment underwriting agreement is the most common type of underwriting. In this agreement, the underwriter agrees to purchase and sell all the securities offered by the company, taking on the financial risk if they are not sold. The underwriter buys the securities at a discounted price from the company and then sells them to investors, pocketing the difference as its profit. This type of agreement provides a guaranteed source of funds for the company.
2. Best Efforts Underwriting
Unlike firm commitment underwriting, best efforts underwriting doesn`t offer the same level of protection for the company. Here, the underwriter only agrees to make its best effort to sell the securities but doesn`t guarantee that all of them will be sold. If the offering falls short of the target amount, the company may receive less capital than it had hoped for. This type of agreement is often used for securities offerings that are riskier or harder to sell.
3. Standby Underwriting
Standby underwriting is typically used for rights offerings, which are the issuance of new securities to existing shareholders. Under this type of agreement, the underwriter agrees to purchase any unsold securities at the end of the offering period, ensuring that the company raises the intended amount of capital. Standby underwriting provides a safety net for companies wanting to raise capital, giving them more confidence when offering new securities.
4. All-or-None Underwriting
All-or-none underwriting is a type of agreement that requires all the securities in the offering to be sold. If the underwriter fails to sell all the securities, the offering is canceled, and the company receives no capital. While this type of agreement provides some level of protection for the company, it can be risky for underwriters who bear the risk of not selling all the securities.
In conclusion, underwriting agreements play a crucial role in financing, helping companies raise capital through the issuance of securities. By understanding the different types of underwriting agreements, companies can choose the best option for their needs and minimize their risk. Whether it`s firm commitment, best efforts, standby, or all-or-none underwriting, each type of agreement has its unique characteristics and benefits. Regardless of the type of underwriting used, it is essential to work with experienced underwriters to ensure that the offering is successful.