Bought Deal (IPO) - Explained
What is a Bought Deal?
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Table of ContentsWhat is a Bought Deal?How does a Bought Deal Work?A Bought Deal and Other Forms of Initial Public OfferingsAcademic Research on Bought Deals
What is a Bought Deal?
A bought deal is a type of deal in which an underwriter, an investment bank or a syndicate commits to purchasing the entire stock of a company in an initial public offering (IPO), even before the preliminary. In a bought deal, the investment bank or underwriter gives an assurance of buying the entire offering from the issuing company before a preliminary prospectus is filed. A bought-deal also gives an assurance to the issuer that the amount intended to be generated through an IPO will be realized.
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How does a Bought Deal Work?
A bought-deal suggest that an investment bank is willing to take all the risk of the securities being issued by a company by committing to buy the securities before the preliminary. While this type of deal offers a guarantee to the issuing company that it will reach its target of fundraising through the issuance of the securities, an investment bank must find means to sell the acquired securities if profit must be made.
The investment bank takes all the risks of the securities in the sense that the securities might lose value and be sold at a lower price. Another risk that an investment bank might incur is the risk of poor sales. In order to hedge the risk, the bank might request a discount from the issuing company or collaborate with other investment banks to purchase the securities.
A Bought Deal and Other Forms of Initial Public Offerings
A bought deal is associated with an initial public offering, it is when an underwriter such as an investment bank commits to buy the securities of an issuing company even before the preliminary. The major types of IPOs are fixed price IPO and book building IPO. An underwriter is needed for any of these IPOs to facilitate the process. A fixed price offer is one in which the price of the shares of the issuing company is predetermined by the company.
The investors are aware of the selling price of the shares even before the company goes public. In a book building IPO, on the other hand, an underwriter determines the price of the securities to be issued. The price is set based on the demand for the shares by investors Regardless of the type of IPO a company wants to execute, an underwriter such as an investment bank is needed to perform the following duties;
- Create an IPO team which comprises experts, the regulatory body such as the Securities and Exchange Commission (SEC) in the U.S, lawyers, public accountants and underwriters.
- Make information about the issuing company available to the investors and other participants.
- Compile the financial information of the issuing company and submit for audit.
- Make projections of the future operations of the company.
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