Page 172 - Initial Public Offering - An Introduction to IPO on Wall Street

The investment bank compiles a registration statement to be submitted to the State regulators
once all parties agree to an arrangement. This document provides details on the offer as well
as business information such as financial reports, history of management, any legal concerns
regarding where the money will be utilized, and insider holdings. A "cooling-off period," is
then required by the regulator where they review and ensure all relevant information has been
disclosed.

After the offer is accepted by the regulator, a date is fixed (the effective date) when the stock
will be sold to the public. The underwriter sets up what is referred to as ‘the red herring’ during
the cooling-off period. This is a preliminary prospectus comprising all the business material,
except for the price of the offering and the effective date, which are not known at that moment.

The underwriter and business look to generate confidence in the issue once they have the red
herring in hand. They go on a roadshow where they pursue the major institutional investors.
The underwriter and the business sit together and discuss the offer as the effective date
approaches. This is not an easy choice: it is dependent on the business, the road show's
effectiveness, and most critically, existing market conditions.

Once the price is decided and the IPO becomes effective, the shares of the company are sold
on the stock change and money is generated from the sale to investors.

A business that is already listed on the market can, via another public offering, issue more
shares for different reasons. As shares have already been issued by an IPO, this practice is
known as a secondary offering. This is also sometimes alluded to as a "new issue".

11.2 Types of Underwriting Commitments
Each underwriting deal differs, especially in the amount of risk that the underwriters decide
to take on and how they are paid. There are three key types of commitments agreed by an
investment bank when an underwriter enters into a deal with a business to help raise money.
The three types of underwriting commitments are detailed below.

11.1.1 Best Efforts
The most common type of underwriting agreement is best-efforts commitment. While the
underwriter commits good faith to sell as many of the stock issue at the negotiated price as
possible, for any unsellable shares or deal effectiveness, there is no legal or financial liability
enforced on the underwriter.

In the financial world, an underwriter makes promises the issuer best effort or good faith to
sell as much of its offering as possible. While both parties agree on the sale of certain
securities, the underwriter does not guarantee that all of them will be sold.

Understanding Best Efforts

Not all shares are expected to be sold in the best effort offering. The underwriter and the
issuer would usually agree on a minimum sum of revenue that must be accomplished. Once
the criterion is reached, the underwriter would not be liable for any shares that are not sold.

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