Definition
Underwriting Agreements are contractual arrangements between a company issuing new securities and the underwriting firm. The underwriter agrees to buy these securities, assuming financial risk, with the intent to resell them to investors at a higher price. The agreement typically outlines terms such as fees, representations, warranties and the obligations of all involved parties.
Phonetic
The phonetics of the keyword “Underwriting Agreements” is:ʌndərˈraɪtɪŋ əˈɡriːmənts
Key Takeaways
Sure, here are three main takeaways regarding Underwriting Agreements.“`html
- Function: Underwriting Agreements mainly outline the terms and conditions of underwriting services. Underwriters assure the issuing company that they will purchase all of the securities being offered for sale to the public at a minimum price.
- Risk Mitigation: These agreements can offer a safety net for issuers because underwriters carry the risk of not being able to sell all of the securities on the market, thus protecting the issuing company from financial losses.
- Details: Underwriting Agreements state detailed information such as the underwriting spread (the difference between what the underwriter pays the issuer for the securities and what they sell them for to the investors), pricing information, IPO date, the underwriter’s obligations, information about termination, and specific representations, warranties, and covenants of the issuer.
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Importance
Underwriting Agreements are critically important in business/finance as they represent a legal contract between a group of investors (underwriters) and the issuing company, wherein the underwriters commit to purchase and subsequently resell the company’s securities like shares or bonds, thereby guaranteeing the amount of capital the issuing company will raise. Underwriting Agreements essentially mitigate risks linked to fluctuating market conditions and ensure that the company gets its desired capital. For underwriters, these contracts represent a business opportunity with potential profit margin or commission. The definitive terms mentioned in the agreement like the number of securities, offering price, the form of security, and the underwriting spread, ensure transparency and safeguard the interests of all involved parties.
Explanation
The primary purpose of an underwriting agreement is to transfer the risk of a potential financial loss from an issuer of securities, like a company initiating an Initial Public Offering (IPO), to an underwriter, typically an investment bank or a consortium of banks. When a company wants to issue new securities to the public, they often rely on underwriters to ensure the successful and smooth issuance of these securities. This is especially vital while raising funds in the capital markets. In return, these underwriters receive a commission or a fee for absorbing the risk.The underwriting agreement outlines the terms and conditions relating to the commitment made by the underwriter. It outlines the accuracy of statements made in the prospectus, and highlights the responsibilities of the underwriters, including the number of securities they must sell, and how any unsold securities will be handled. It aids in the successful distribution of securities, while also ensuring the company is able to raise the required capital. In essence, underwriting agreements serve as a shield for the issuer against the financial implications of unsuccessful transactions.
Examples
1. Initial Public Offerings (IPOs): When a company decides to go public, it enters into an agreement with an investment bank or a group of them, known as underwriters. In this underwriting agreement, the underwriters commit to buy the shares being issued and then resell them to the public. For example, Goldman Sachs, JP Morgan and Bank of America Securities were the underwriters when Uber went public in 2019.2. Insurance Policies: The contract between an insurance company and a policyholder is a good example of underwriting agreement. In this, the insurer agrees to pay out claims in case of a certain event (like a fire, accident, or even death depending upon the type of policy) in exchange for the insured party’s premium payment. A real-world example includes Allstate car insurance policy wherein the company underwrites the risks associated with potential accidents.3. Mortgage Underwriting: Banks and other financial institutions use underwriting agreements when giving out mortgage loans. Lenders evaluate the borrower’s credit history, employment status, financial health, and the value of the home to determine the risk level. If the underwriter deems the risk acceptable, the mortgage loan is approved. For instance, Wells Fargo provides mortgage underwriting services to its clients who wish to purchase or refinance their homes.
Frequently Asked Questions(FAQ)
What is an Underwriting Agreement?
An Underwriting Agreement is a contract signed between a group of investment bankers who form an underwriting group and the issuer of a new securities offering. The agreement contains the terms and conditions under which the investment bankers will purchase and resell the new securities to investors.
When is an Underwriting Agreement used?
An Underwriting Agreement is commonly used during the initial public offerings (IPOs), seasoned equity offerings (SEOs), or debt offerings of a company.
What is the primary purpose of an Underwriting Agreement?
The primary purpose of this agreement is to ensure that all the players involved understand their obligation pertaining to the offering. It also ensures the issuer that the securities will be sold at a specific price.
What are the key components of an Underwriting Agreement?
An Underwriting Agreement typically includes features such as the covenants of the issuer and the underwriters, the agreed-upon terms of the offering, the representations and warranties, the compensation for the underwriters, and the closing conditions.
What is the role of the underwriter in an Underwriting Agreement?
The underwriter’s role is to purchase the securities from the issuer and resell them to the public or to dealers. They may also act as agents for the issuers, where they are contracted to sell the securities, but are not required to purchase what they cannot sell to investors.
What risks do underwriters bear under an Underwriting Agreement?
Underwriters bear the risk of not being able to sell the underlying securities to the public, or the risk of having to sell them at a lower price than expected.
What are the different types of Underwriting Agreements?
There are mainly two types: a firm commitment agreement where the underwriter buys the entire issue and takes on full responsibility if the shares cannot be sold, and a best-efforts underwriting agreement where the underwriter does its best to sell as many shares as possible but isn’t required to buy the shares itself.
Can an Underwriting Agreement be terminated?
Yes, under certain conditions, such as misrepresentation of the issuer’s state of affairs, a change in the market conditions, or failure to comply with the prerequisites, an underwriting agreement can be terminated.
Related Finance Terms
- Risk Assessment
- Indemnity Clause
- IPO (Initial Public Offering)
- Securities Distribution
- Due Diligence
Sources for More Information
