Purchase of the stock by the underwriters: Overview, definition, and example
What is the purchase of the stock by the underwriters?
The purchase of the stock by the underwriters refers to the process in which underwriters, typically investment banks, agree to buy shares of a company’s stock during an Initial Public Offering (IPO) or a secondary offering. Underwriters play a key role in helping a company go public or raise additional capital by purchasing the shares from the company at a set price and then selling those shares to the public at a higher price. The underwriters assume the risk of distributing the stock and may profit from the difference between the purchase price and the price at which they sell the shares. This process is often referred to as a "firm commitment" underwriting.
In simpler terms, the purchase of stock by the underwriters is when investment banks buy shares from a company to sell them to the public during an IPO or stock offering.
Why is the purchase of the stock by the underwriters important?
The purchase of the stock by the underwriters is important because it provides the company with the capital it needs, while also offering investors a chance to buy shares of the company. Underwriters help ensure that the stock is sold at a fair price and that the process runs smoothly. They also take on the risk of selling the shares, meaning that if the shares do not sell to the public as expected, the underwriters may absorb the loss. This guarantees that the company raising funds gets the agreed-upon capital regardless of market conditions. For the company, it ensures that its stock is sold to the public in a structured and regulated manner.
For SMB owners considering going public, understanding the purchase of stock by underwriters is essential for knowing how the IPO process works and what role underwriters play in raising capital.
Understanding the purchase of the stock by the underwriters through an example
Let’s say your company decides to go public and conducts an IPO. You hire an investment bank as the underwriter, and they agree to buy 1 million shares of your stock at $10 per share. The underwriter then sells these shares to the public at $12 per share. The investment bank earns a profit from the $2 difference per share, while your company receives the full $10 million from the sale of the stock. This transaction allows your company to raise funds while providing the underwriter with a financial reward for taking on the risk and handling the sale.
In this case, the underwriter’s purchase of the stock helps your company raise the necessary capital for growth or expansion.
Example of the purchase of stock by the underwriters clause
Here’s an example of what a "purchase of the stock by the underwriters" clause might look like in an underwriting agreement:
“The Underwriters agree to purchase [X] shares of the Company’s common stock at a price of $[X] per share, with the intent to resell the shares to the public at an offering price of $[X] per share. The Underwriters shall have the option to purchase up to an additional [Y] shares at the offering price to cover over-allotments.”
Conclusion
The purchase of stock by the underwriters is a crucial part of the IPO process, allowing a company to raise capital by selling its stock to the public. For SMB owners, understanding how this works helps in preparing for a successful public offering and knowing the role underwriters play in setting the stock price and managing the sale. This process provides the business with the funds it needs, while allowing underwriters to earn a profit for their services in managing and distributing the stock.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.