Legal Definitions - best-efforts underwriting

Best-efforts underwriting is an agreement where an underwriter commits to selling as many securities as possible from an issuer's offering.

Unlike other underwriting types, the underwriter does not guarantee the sale of all securities and is not obligated to purchase any unsold shares, leaving the financial risk of an unsuccessful offering with the issuer.

Best-efforts underwriting is a type of agreement between a company seeking to raise capital by issuing securities (such as stocks or bonds) and an investment bank, known as an underwriter. In this arrangement, the underwriter commits to using its diligent efforts to sell the securities to investors.

However, unlike other underwriting agreements, the underwriter does not guarantee that all the securities will be sold, nor does it promise a specific amount of money will be raised for the issuing company. The risk of unsold securities remains with the company that is issuing them. This method is often chosen by companies that are smaller, newer, or have offerings that might be considered higher risk, as it places less financial obligation on the underwriter compared to a "firm commitment" underwriting, where the underwriter purchases all the securities from the issuer and then resells them.

Here are some examples to illustrate best-efforts underwriting:

• Imagine a new software company, InnovateTech Solutions, wants to raise $20 million to fund its expansion by selling shares to the public. They engage an investment bank, Global Capital Partners, under a best-efforts underwriting agreement. Global Capital Partners actively markets InnovateTech's shares to its network of institutional and individual investors, hosts investor presentations, and facilitates the sale process. If, after a specified period, they only manage to sell $15 million worth of shares, InnovateTech Solutions will receive only that amount. Global Capital Partners is not obligated to purchase the remaining $5 million in unsold shares, provided they can demonstrate they used their "best efforts" to sell them. The risk of not raising the full $20 million falls entirely on InnovateTech Solutions.

• Consider GreenLeaf Energy, a small renewable energy firm, which aims to issue $10 million in corporate bonds to finance the construction of a new solar farm. They partner with Community Investment Bank on a best-efforts basis. Community Investment Bank promotes these bonds to its client base, highlighting the investment opportunity. Despite their marketing efforts, they only find buyers for $8 million worth of bonds. In this scenario, GreenLeaf Energy receives $8 million, and Community Investment Bank is not responsible for selling the remaining $2 million in bonds or for any shortfall in the fundraising target, as long as they fulfilled their commitment to use their best efforts in the sales process.