What is Undersubscribed?
In the securities industry, undersubscribed means that an offering does not have enough buyers.
How Does Undersubscribed 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. 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). With riskier issues, sometimes underwriters act on a “best efforts” basis, whereby they sell what they can and return the unsold shares.
After the syndicate is assembled, the issuer files an SEC Form S-1, which is also called a prospectus. The prospectus discloses 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 questions of the management team. If the buyers like the offering, they make a nonbinding 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 underwriter gauge the demand for the offering (called “indications of interest”) and determine whether the contemplated price is fair. If the underwriter is not able to get enough interest in the number of shares for sale, the offering is undersubscribed.
Why Does Undersubscribed Matter?
Undersubscribed offerings are often a matter of overpricing the securities for sale. If the demand is too low, the underwriter and issuer might lower the price to attract more subscribers. Once the underwriter is sure it will sell all of the shares in the offering, it closes the offering. Then it purchases all the shares from the company (if the offering is a guaranteed offering), and the issuer receives the proceeds minus the underwriting fees. The underwriters then sell the shares to the subscribers at the offering price.
It is important to note that 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.
