Page 176 - Initial Public Offering - An Introduction to IPO on Wall Street

11.1.3 Stand-By
Standby underwriting is a type of arrangement for the sale of stock in an initial public
offering (IPO) wherein the investment bank offers to buy any remaining shares after selling
all the shares it can to the public.

The underwriter decides, in a standby deal to buy any shares that remain at the subscription
price, which is usually lower than the market price of the stock. This form of underwriting
assures the issuer that a certain sum of money would be raised by the IPO.

Understanding Stand-By Commitment

Although the opportunity to buy a stock below the market price may seem to be a benefit of
standby underwriting, the offering’s lack of demand is apparent because there are shares still
left to be bought by the underwriter.

Standby underwriting thus shifts liability to the investment bank (the underwriter) from the
business that is going public (the issuer). The underwriter's fee could be higher due to this
increased risk.

Stand-by-underwriting is often referred to as strict or old-time-underwriting. It is a type of
underwriting in which an investment bank or insurer decides to purchase part of the new
stock issue that will remain after the IPO.

Insurers would do their utmost to sell all the shares on sale in the best subcontracting, but the
insurers are under no obligation to purchase all the shares. This kind of subcontracting
arrangement is typically at stake when the market for an offer may be unstable. The unsold
shares are returned to the issuer under this form of arrangement.

In a firm commitment, the investment bank makes a promise for the acquisition of all the
securities sold by the issuer to the seller, whether or not it is willing to sell the stock to
buyers. Issuers favor firm commitment deals and others over standby locking arrangements
since they assure all the money immediately.

The insurer would also insist on an escape clause in the case of a firm commitment that will
release them from the responsibility to purchase all shares in the event of an arrangement
affecting the quality of the securities.

In general, weak market conditions are not an appropriate explanation, but drastic shifts in the
company's business when the market reaches a soft fix or other IPOs' bad results are often
explanations why the exit provision is asked for by the underwriter. A firm commitment and
a best efforts arrangement are other choices for the IPO

As a rule of thumb, only if there is a high demand for the IPO because it alone carries the
risk, a subsystem will agree to a firm commitment by asking the insurer to put its own money
at risk. They have to find out what to do with the outstanding shares if they can't sell all
shares to customers; they can choose to retain them in the expectation of the demand
increasing, or perhaps try to offload them with a discount, retaining a loss on the shares.

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