What is a Lead Underwriter?
In the securities industry a lead underwriter is a company, usually an investment bank, that helps companies introduce their new securities into the market by leading a syndicate of investment banks to issue the securities.
How Does a Lead Underwriter Work?
When a company decides it wants to issue stock, bonds, or other publicly traded securities, it hires an underwriter to manage what is a long and sometimes complicated process.
To begin the offering process, the underwriter and the issuer first determine the kind of offering the issuer needs. Sometimes the issuer wants to sell shares via an initial public offering (IPO). In this case, the proceeds go back to the company, but other offerings such as secondary offerings funnel the proceeds to a shareholder who is selling some or all of his or her shares.
After determining the offering structure, the underwriter usually assembles what is called a syndicate to get help managing the minutiae (and risk) of particularly large offerings. A syndicate is a group of other investment banks and brokerage firms that commit to sell a certain percentage of the offering (this is called a guaranteed offering because the underwriters agree to pay the issuer for 100% of the shares, even if they can’t sell them all). The lead is the underwriter, which has the responsibility for assembling and managing the syndicate throughout the process. That means it is primarily responsible for assembling the 'sales force' that will sell the securities.
After the syndicate is assembled, the lead underwriter usually writes and files an SEC Form S-1, which is also called a prospectus. 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, the name and addresses of key company officers, the salaries and business histories of each officer, the ownership positions of each officer, the company’s capitalization, an explanation of how it will use the proceeds from the offering, and descriptions of any legal proceedings the company is involved in.
Prospectus in hand, the underwriter then sets to selling the securities. This usually involves a road show, which is a series of presentations made by the underwriter and the issuer’s CEO and CFO to institutions (pension plans, mutual fund managers, etc.) across the country. The presentation gives potential buyers the chance to ask the management team questions. If the buyers like the offering, they make a non-binding commitment to purchase, called a subscription. Because there may not be a firm offering price at the time, purchasers usually subscribe for a certain number of shares. This process lets the lead 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 lead underwriter’s biggest responsibilities for two reasons. First, the price determines the size of the proceeds to the issuer. Second, it determines how easily the underwriter can sell the securities to buyers. Thus, the issuer and the lead underwriter work closely together to determine the price. Once the issuer and the lead underwriter agree on how to price the securities and the SEC has made the registration statement effective, the underwriters call the subscribers to confirm their orders. If the demand is particularly high, the underwriters and issuer might raise the price and reconfirm this with all the subscribers.
Once the syndicate is sure it will sell all of the shares in the offering, it closes the offering. The syndicate purchases all the shares from the company (if the offering is a guaranteed offering), with the lead underwriter typically buying the largest portion. The issuer receives the proceeds minus the underwriting fees. The underwriters then sell the shares to the subscribers at the offering price.
Although the underwriters influence the initial price of the securities, once the subscribers begin selling, the free-market forces of supply and demand dictate the price. The lead underwriter usually maintains 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.
Why Does a Lead Underwriter Matter?
Lead underwriters grease the skids for bringing securities to market. Issuers compensate them for this by paying a spread, which is the difference between what the issuer receives per share and what the underwriter sells the shares to the subscribers for. For example, if XYZ Company shares had a public offering price of $10 per share, XYZ Company might only receive $9 per share if the underwriter takes a $1-per-share fee (the lead underwriter shares this with the syndicate but gets a larger portion of that $1). Making a market in the securities also generates commission revenue for underwriters.
As we mentioned earlier, underwriters take on considerable risk, and the lead underwriters especially so. Not only must they advise 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.