Understanding Underwriting Agreements?

An underwriting agreement is a significant legal contract between a corporation issuing new securities and the underwriters who commit to sell them. This contract, often overseen by an investment bank, outlines the terms and details of the transaction, including the agreed-upon price for the securities and the underwriters’ responsibilities.

Types of Underwriting

Different types of underwriting commitments serve unique purposes.

Firm commitment underwriting contract: In these contracts the underwriter guarantees the sale of the issued stock, agreeing to purchase all the securities offered by the issuer, which they will resell to investors. If any securities remain unsold, the underwriter absorbs the cost.

Best efforts underwriting contract: In these contracts the underwriter makes a best effort to sell the securities but does not guarantee the sale. This underwriting process shifts the potential risk back to the issuer.

Mini-Maxi Agreements: These agreements are a special kind of arrangement where the sale of securities only kicks off after a set minimum amount is sold. The sale can continue until it hits a predetermined maximum limit. Before the deal is sealed, all the money from investors is kept safe in escrow. If the sales don’t reach the minimum target, the whole thing is called off, and investors get their money back.

All or None Deals: In this scenario, the issuer has set a goal to sell every single security. The money from investors is stored in escrow until every piece of the security is sold. If the goal is met, the money goes to the issuer. But if not, the deal is scrapped, and investors are refunded.

Standby Underwriting: This method is chosen when there’s an offering that gives current shareholders the first dibs to buy more shares. Standby underwriting is always based on a firm commitment. Here, the underwriter is ready to buy any shares not picked up by the current shareholders. These shares are then sold to the general public.

Who are the Underwriters?

Underwriters are a crucial part of any securities offering on a firm commitment basis. They are typically a group of investment banks that work together to sell the offered securities to investors. This group is often referred to as an agreement among underwriters or an underwriting syndicate.

The underwriters’ role is to buy the securities from the issuing company and then sell them to investors. In a firm commitment offering, the underwriters agree to buy all the securities from the issuer and then sell them to the public. This means that the underwriters bear the risk of not being able to sell all the securities offered.

The provisions of the underwriting agreement outline the obligations of each party. It typically provides the underwriters with the details of the securities being offered, including the number of shares and the offering price. The agreement also describes the key sections of the underwriting process, such as due diligence, marketing, and settlement.

In the U.S, underwriters play a significant role in both equity and debt securities offerings. They help companies raise capital by selling securities to the public, and they also provide a market for these securities.

The underwriters’ role is not without risks. If they are unable to sell the entire offering, they may have to hold onto the securities themselves. This is why the underwriting agreement often includes an over-allotment option, also known as a greenshoe option, which allows the underwriters to sell more shares than initially planned if there is high demand from investors.

In conclusion, underwriters are a key party in a securities offering. They facilitate the process of selling securities to the public and bear the risk of the offering. Their role and responsibilities are outlined in the underwriting agreement, which is a critical document in any securities offering.

When are Underwriting Agreements used?

Underwriting Agreements are crucial instruments utilised extensively in the financial world, specifically when a company decides to issue new securities to the market. The underwriting agreement is a contract that outlines the responsibilities and roles of the parties involved, ensuring the necessary financial backing for the securities offering.

IPO and Private Placements

One of the most common scenarios where underwriting agreements are used is during an Initial Public Offering (IPO). The underwriting agreement may stipulate that the underwriter agrees to sell a specific number of shares to the public. This process is guided by practical law, and the underwriting group or underwriter syndicate is often led by a lead underwriter who helps the company issuing the new securities to navigate through the complex process.

In addition to IPOs, underwriting agreements are also used in private placements. This scenario typically involves a small number of shares that the underwriter agrees to sell to a select group of investors.

Drafting the Agreement

The draft of the underwriting agreement is a meticulous process. It covers the typical provisions of an underwriting agreement, including the commitment of the underwriter, the settlement date, the underwriter’s obligations to purchase all or a portion of the securities, and the circumstances under which the underwriter may cancel the deal.

The agreement also provides detailed commentary on the typical provisions, outlining the underwriter’s indemnity clauses, the rights and obligations of the company agreeing to sell the securities, and the potential risks involved.

Firm Commitment and Best-Efforts Agreements

Underwriting agreements can either be on a firm commitment basis or a best-efforts underwriting agreement. In a firm commitment agreement, the underwriters guarantee the sale of all the securities offered, taking a significant risk upon themselves. In contrast, in a best-efforts agreement, the underwriters will make their best effort to sell the securities, but there’s no guarantee that all securities will be sold.

After the Agreement

Once the underwriting agreement has become effective, the underwriters are provided with the securities and they commence the initial resale. The underwriters will purchase the securities at an agreed-upon price and then resell them to investors. If any securities remain unsold, the underwriting agreement will dictate the procedures to follow.

In summary, underwriting agreements are used when a company wants to issue new securities, whether through an IPO or private placements. These agreements are a cornerstone of financial offerings of equity, ensuring the securities are sold and the company can raise the funds it needs.

Key Provisions of Underwriting Agreements

An underwriting agreement includes several key provisions. The issuer’s representations and warranties, covenants, and indemnification and contribution provisions are among the essential clauses.

In the representations and warranties section, the issuer attests to the accuracy of the information in the prospectus and any other disclosure documents. This section often requires negative assurance from the underwriters, confirming that nothing has come to their attention that causes them to believe that the prospectus is misleading.

Covenants detail the issuer’s and underwriters’ operational and behavioural commitments for the period between signing the agreement and closing the offering.

The indemnification and contribution provisions protect the underwriters against potential losses or liabilities arising from misstatements or omissions in the prospectus or issuer’s non-compliance with securities laws.

Understanding the Underwriting Process

The underwriting process is a critical phase in a securities offering, where the underwriters perform due diligence on the issuer and the securities offered. This process includes the underwriting of the securities, which involves a thorough examination of the issuer’s financial health, business model, and market position.

The underwriters, often working as a syndicate, are tasked with the responsibility of marketing the securities and coordinating their initial resale to investors. This is a crucial step as it determines the success of the securities offering. The underwriters provide commentary on the typical aspects of the securities, including their potential returns, risks, and the issuer’s financial stability. This note provides commentary that is essential for investors to make informed decisions.

Once the underwriting agreement is formalised, the underwriters have the obligation to sell the securities. In some cases, the underwriter agrees either to sell the entire offering or to cancel the deal if they cannot sell all the securities. This is known as a ‘firm commitment’ underwriting, where the underwriters take on significant risk.

The underwriting process also involves the party’s stockholders, who may be offered the securities first in a ‘rights offering’. This allows existing stockholders to maintain their proportional ownership in the company, which can be an attractive option for investors.

The underwriting process is a complex and critical phase in a securities offering. It involves various parties and requires the underwriters to perform due diligence, market the securities, and coordinate their initial resale to investors.

The Role of Underwriters in Public Offerings and IPOs

Underwriters play a crucial role in public offerings and initial public offerings (IPOs). The underwriter or a group of investment bankers work closely with the issuer, crafting a prospectus that provides potential investors with details about the offering of securities. The underwriters then take on the responsibility to sell these securities to the investors.

Termination Rights and Closing Conditions

Underwriting agreements detail the termination rights of the parties. They can cancel the deal under certain conditions. These closing conditions typically include changes in market conditions, inaccuracies in the issuer’s representations, or non-compliance with the covenants.

Underwriting Agreements: The Cornerstone of Securities Offerings

Whether it’s an all-or-none contract, a firm commitment contract, or a best efforts underwriting agreement, underwriting agreements are the cornerstone of any securities offering. As a specialist in Corporate Law and Commercial Law, Alt-X Law can provide expert guidance through every step of the underwriting process, ensuring that your interests are protected and the process is compliant with UK law. You can navigate the complexities of underwriting agreements with confidence.

AI Disclosure:

For full transparency, we disclose that this article has been written with the assistance of AI. All of the content and information in this article has been extensively reviewed, rewritten, expanded and vetted by the author who is a qualified Barrister-at-Law specialising in Corporate Law and Commercial Law.