Best Efforts (IPO Underwriting) - Explained
What is Best Efforts Underwriting in an IPO?
Written by Jason Gordon
Updated at April 15th, 2022
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Table of Contents
What is Best Efforts Underwriting in an IPO? How does Best Efforts Underwriting Work? Academic Research on Best Efforts by UnderwritersWhat is Best Efforts Underwriting in an IPO?
During an initial public offering, the offering company hires an investment bank (or other financial institution) to underwrite the process. The underwriter attempts to get commitments from its investor connections to purchase the shares being offered in the IPO. As compensation, the underwriter receives a block of the shares that it can hold or sell for a profit. Best Efforts underwriting is when an underwriter agrees to give his or her highest personal effort to sell as much as possible of the IPO shares. This can be compared to firm commitment underwriting where the underwriter guarantees sale of the block of shares or it will purchase any unsold shares.
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How does Best Efforts Underwriting Work?
Best efforts agreements gives relief to underwriters from the obligation to purchase any of the shares they cannot sell. In a best-efforts contract, the underwriter refrains from promising the entire IPO issue will get sold.
Underwriters receive a set amount for their services in a best-efforts agreement, so not only is the underwriters risk limited but also the underwriters potential for profit. With best-effort shares, the investment bank can act as an agent making its best effort to sell the stock issue. The investment bank does not buy all of the public securities. Instead, the bank can decide to buy only the share adequate to satisfy client demand.
Also, the bank has the option to cancel the whole stock issue and lose out on receiving a fee. There can sometimes be conditions included in best-efforts offerings, such as part-or-none and all-or-none. All-or-none shares must be sold completely to close the deal. Whereas, part-or-none offerings, require only a designated number of securities to qualify for deal closure.
Public offerings can get handled in different ways by issuers and underwriters. In opposition to a best-efforts agreement, a firm commitment, also known as a bought deal, means the underwriter is required to purchase full shares offering. The profit earned depends on the number of bonds or shares sold and on the extent of the difference between the price the shares were sold for and the underwriters marked down purchase price.
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