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What is an Equity Underwriter? 

An equity underwriter plays an important role in the initial public offering or IPO process. 

Equity underwriters are usually investment banks with a team of IPO specialists. They help to market, distribute and administer the public issuance of securities, usually common or preferred stock. They work closely with the issuing company to ensure that the company meets all regulatory requirements. 

The IPO specialists also contact a large network of investment organizations -- such as mutual funds and insurance companies -- to gauge investment interest. This helps an underwriter set the IPO price of the company's stock, the more interest they get the higher the offer price of the stoc. The underwriter also guarantees that a specific number of shares will be sold at that initial price. Anything that doesn't sell will be purchased by the underwriter. This guarantees the stock will be liquid. 

What is the Equity Underwriting Process?

The underwriter and issuer need to first determine the kind of offering the issuer needs. A common offering is when the issuer wishes to sell shares via an initial public offering (IPO) in order to receive cash. 

Other offerings include:

  • Secondary offerings: this funnels the proceeds to a shareholder who is selling some or all of his or her shares

  • Split offerings: This occurs when a portion of the offering goes to the company while the rest of the proceeds goes to an existing shareholder

  • Shelf offerings: This allows the issuer to sell shares over a two-year period

 
After determining the offering structure, the underwriter may assemble a syndicate to help manage large offerings. A syndicate is a group of investment banks and brokerage firms that commit to sell a certain percentage of the offering. It’s called a guaranteed offering because the underwriters agree to pay the issuer for 100% of the shares, even if all the shares can't be sold. 

With riskier issues, underwriters often act on a "best efforts" basis where they sell as many shares as they can, but no guarantees are made.
 
The issuer files a prospectus after the syndicate is assembled. The Securities Act of 1933 requires the prospectus to fully disclose all material information about the issuer, including:

  • A description of the issuer's business

  • Name and addresses of key company officers

  • Salaries and business histories of each officer

  • Ownership positions of each officer

  • The company's capitalization

  • An explanation of how it will use the proceeds from the offering

  • Descriptions of any legal proceedings the company is involved in

 
With prospectus in hand, the underwriter then proceeds to market the securities by going on a "road show". This is where they give a series of presentations made by the underwriter and the issuer's key executives to financial institutions across the country. The presentation gives potential buyers the chance to ask questions from the management team. 

If the buyers like the offering, they make a subscription, a non-binding commitment to purchase. 

Purchasers usually subscribe for a certain number of shares because there may not be a firm offering price at the time. This process lets the underwriter gauge the demand for the offering -- called indications of interest -- and determine whether the contemplated price is fair.

Determining the final offering price is one of the underwriter's most important responsibilities. That’s because the price determines the size of the capital proceeds and an accurate price estimate makes it easier for the underwriter to sell the securities. 

Once an agreement is reached on price and the U.S. Securities and Exchange Commission (SEC) has made the registration statement effective, the underwriter calls the subscribers to confirm their orders. If the demand is high, the underwriter and issuer might raise the price and reconfirm this with all the subscribers.
 
The underwriter will close the offering once it’s sure it will sell all of the shares. Then, it’ll purchase the agreed-upon amount of shares from the company and the issuer receives the proceeds minus the underwriting fees

The underwriters then sell the shares to the subscribers at the offering price, or to others if they’ve withdrawn their bids. 
 
Although the underwriter influences the initial price of the securities, once the subscribers begin selling, the free-market forces of supply and demand dictate the price. Underwriters usually maintain a secondary market in the securities they issue, which means they agree to purchase or sell securities out of their own inventories in order to keep the price of the securities from swinging wildly.

What is the Typical Equity Underwriter Fee?

Typical equity underwriting fees are 6% to 7% of proceeds, depending on the financial institution. Some statistics show that the lower the gross proceeds from the IPO, the higher the percentage charged. 
 

Ask an Expert about Equity Underwriter
At InvestingAnswers, all of our content is verified for accuracy by Mark Herman, CFP and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Equity Underwriter.

Do Underwriters Intentionally Underprice IPOs?

To answer this question, you need to recall that the underwriter is potentially exposed to a certain amount of risk when they provide a firm commitment, in that they may have to sell shares at less than the offer price and take a loss.

However, this rarely happens as the vast majority of IPOs increase in price on the first day of trading. So, in a way underpricing an IPO actually reduces an underwriter’s exposure to loss. 

Can I Profit from Buying an IPO and Immediately Selling?

The average one-day price appreciation of an IPO between 1980 and 2020 was 18.4%. There are many reasons for this phenomenon, from media hype to underpricing and a premium for liquidity. So, can an average investor profit by repeatedly purchasing an Initial Public Offering with the plan to sell immediately once it ‘pops’ by 18.4% on average? The short answer is not in practice. 

The demand for IPOs often exceeds the supply, especially if the IPO is underpriced as discussed. When this happens, an investor’s allocation of shares (i.e. what they have committed to purchase) are rationed. However, if the IPO does not go as well and demand is weaker, all orders are completely filled at the offer price and the stock price is likely to decline initially. This is called the ‘winner’s curse’ and impacts the returns for those who participate in IPOs. 

Mark Herman has been helping friends with financial questions since serving as an Army helicopter pilot. Since then, he’s gained valuable experience in the corporate world before moving on to become a CERTIFIED FINANCIAL PLANNER™.

If you have a question about Equity Underwriter, then please ask Mark.

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