Page 115 - Initial Public Offering - An Introduction to IPO on Wall Street

intermediary to help the issuing business sells its initial collection of stocks. The issuing firm
has the following underwriting provisions at its disposal:

Firm Commitment

The underwriter buys the entire bid under such an arrangement and resells the stock to the
buying public. This arrangement ensures that a certain amount of money will be received by
the issuing entity.

Best Efforts Agreement

In such an arrangement, the underwriter does not promise to the issuing firm the sum they will
collect. It only sells the shares on behalf of the business.

All or None Agreement

There is no agreement and the agreement stands canceled unless it is possible to sell all the
shares offered.

Syndicate of Underwriters

IPOs carry great risk sometimes and the underwriting bank chosen may not want to assume all
of that risk. In this scenario, under the main bank, a coalition of banks would come together to
form an association. Public offerings may be handled by one (sole controlled) underwriter or
by many managers.

One investment bank is chosen as the main or underwriting manager when there are several
banks involved. Such an arrangement occurs when the main investment bank seeks to expand
the risk of an IPO among multiple banks.

The following documents may be drafted by the underwriting bank:

Engagement Letter

Generally, an engagement letter includes:

1) Reimbursement Clause: This provision demands that the issuing firm, even if the IPO is
revoked during the marketing phase, the registration phase, or the due diligence phase, must
pay all out-of-the-pocket costs paid by the underwriter.
2) The Gross Spread: By deducting the price at which the issue is bought by the underwriter
from the price at which the issue is sold by them, the Gross Spread is obtained.

The gross spread is usually set at 7 percent of the earnings. To compensate the underwriter, the
gross spread is utilized.

The lead underwriter is compensated 20 percent of the aggregate spread if there is a syndicate
of underwriters. 60% of the spread that remains, referred to as the "sale concession," is divided
between the syndicate subscribers based on the total issues sold by the underwriter, The 20
percent of the gross spread that remains is utilized to cover subscription costs such as
expenditures for roadshows, consultants, etc.

Letter of Intent

Generally, the following information is included in a letter of intent:

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