Page 174 - Initial Public Offering - An Introduction to IPO on Wall Street

When an investment bank commits to best-effort shares, it attempts to act as a broker that
makes its best effort to sell the stock issue. Not all of the public shares are purchased by the
investment bank. Instead, the bank may decide to purchase only the appropriate share to meet
customer demand. The bank also has the option of canceling the entire stock issue and losing
out on earning a fee.

In addition to the above, conditions can often be included in best-effort offers, such as part-
or-none and all-or-none. To seal the deal, all-or-none shares need to be fully sold. On the other
hand, part-or-none offers only require selling a specified number of securities to qualify for
the closing of the deal.

11.1.2 Firm

The underwriter offers to buy the whole issue at a specific price in the event of a firm
commitment. The underwriter assumes full financial liability for any purchased securities it
fails to sell the entire issue. The payout to the underwriter is the difference between the price
the underwriter pays for the securities and the price it earns by reselling them.

In this scenario, the underwriters assume the entire risk of the stock issue being sold. Instead
of waiting on unsold shares, they want to find purchasers for the whole new issue.

In the financial world, a firm commitment has three general definitions but is most
recognizable as the willingness of an underwriter to accept all inventory risk and buy all
securities for an IPO directly from the issuer for public selling. The firm commitment is often
referred to as a ‘bought deal’.

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