Underwriting Solution

Underwriting involves the issuing company using one or (usually) more companies who are each responsible for placing a certain amount of the new issue. The underwriting firms contact potential investors to gauge interest and sell the issue. Underwriters guarantee the price for a certain number of shares of the new issue.

An investment bank underwrites an initial public offering (IPO) or a bond issue when it buys the shares or bonds from the issuer and takes the risk of having to sell them to individual or institutional investors to recover its investment.

Underwriters bring a company's securities to market. In so doing, investors become more aware about the company. Issuers compensate underwriters by paying a spread, which is the difference between what the issuer receives per share and what the underwriter sells the shares for. Making a market in the securities also generates commission revenue for underwriters. Often a lead underwriter and several other underwriters will work together on a given issue.

As we mentioned earlier, underwriters take on considerable risk. Not only must they inform a client about matters large and small throughout the process, they relieve the issuer of the risk of trying to sell all the shares at the offer price. Underwriters often mitigate this risk by forming a syndicate whose members each share a portion of the shares in return for a portion of the fee.