As a future investment banker, you will basically perform two functions for clients, the first is M&A advisory and the second is underwriting. Many of you are familiar with the concept of underwriting in the context of the insurance industry. However, underwriting from an investor’s perspective, the subject of today’s blog post, is an entirely different process.
What is subscription?
Critically, we need to understand the term underwriting from an investment banking perspective.
Simply put, underwriting is the process by which an investment bank raises capital for an organization, either in the form of equity or debt. The organization can be a corporation, government or government agency, or any other institution that needs funding. An investment bank will issue and sell stocks or bonds on behalf of the organization to investors, either through an initial public offering (IPO) or watchlists. In return, the investment bank will receive a commission.
Now that you have an essential understanding of the underwriting process at a very high level, let’s explore the different phases it involves.
Underwriting is basically a three-phase process, the first being planning, followed shortly by assessing the timing and demand for the show, and finally establishing the show structure.
At this point, it is crucial for the investment banker to properly assess the two themes investors are currently investing their money in, and then understand the sentiment behind them. By equipping yourself with these two crucial pieces of information, you will be able to easily judge both the demand and the interest of the offer among investors.
2. Application and timeline:
Once the planning is complete, it is essential to assess the demand and timing issues of the expected supply. Since these two factors are crucial in determining the success of the planned underwriting activity, it is essential to ask yourself;
a. current market and investor appetite for investment in the organization
b. what does the ideal investor look like
vs. what is the precedent for similar transactions
3. Structure of the problem:
In the final stage of the process, once the planning and market research have been completed, the investment bank must define the structure of the issue. In this regard, he will have to determine whether to position the issue nationally or internationally, whether the investors represent institutions, will there be participation from individual investors, what will be the final price of the issue and how will the sale actually take place?
Types of subscription
Now, as you might have guessed, there are several types of underwriting engagements that an investment bank can enter into with its client on the basis of mutual benefit. The most important and commonly used are:
1. Firm commitment:
In this type of commitment, the investment bank guarantees the sale of the entire issue. However, if the condition is not met in any way, the investment bank will take full responsibility and buy back the unsold portion of the issue.
2. Best Effort:
Best effort is the most common commitment made by an investment bank. Here, the underwriter agrees to do his best in good faith to sell the agreed issue; however, they assume no financial responsibility for any unsold components.
3. All or None:
Finally, there is the all-or-nothing commitment in which an investment bank will not receive any commission unless all issues are sold at the agreed price.
Underwriting is an integral part of any investment bank’s business model. Therefore, understanding this process is essential for anyone looking to build a career in the industry.