Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Back-Stop Purchaser

What it is:

A back-stop purchaser buys leftover shares from the underwriter of an equity or rights offering.

How it works (Example):

Company XYZ is going public. It plans to issue 10 million shares in an initial public offering. Its investment bank, Bank ABC, agrees to underwrite the IPO. Bank ABC creates a document detailing Company XYZ's business model, financial forecasts, and the terms of the offering, and it meets with potential investors to gauge their interest in purchasing the shares. After this process is over, Bank ABC has agreements to sell the shares for $25 per share.

However, Bank ABC also comes to a special agreement with John Doe, a wealthy investor, who agrees to be Bank ABC's back-stop purchaser. If for some reason Bank ABC can't sell all the shares in the IPO (this is called the unsubscribed portion), John Doe agrees to buy those leftovers. John Doe, of course, obtains a fee for agreeing to be the back stop because he is taking on the risk of having to purchase (and then trying to reissue) the Company XYZ securities.

Why it Matters:

A back-stop purchaser is like insurance -- the purchaser guarantees in some form that a company (and its investment bank) will raise the money it intends to raise.

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