Legal Definitions - firm-commitment underwriting

Firm-commitment underwriting is a type of agreement in the financial world where an investment bank, known as an underwriter, agrees to purchase an entire issue of securities (such as stocks or bonds) directly from a company or government entity. The underwriter then takes on the responsibility of reselling these securities to the public. The crucial aspect of this arrangement is that the underwriter assumes all the financial risk for any unsold securities. This means the issuing company or entity is guaranteed to receive the full amount of capital it seeks, regardless of whether the underwriter successfully sells all the securities to investors.

• Example 1: Initial Public Offering (IPO) for a Tech Startup

  Imagine a rapidly growing software company, "InnovateTech Inc.," decides to go public through an Initial Public Offering (IPO) to raise capital for expansion. InnovateTech partners with "Global Capital Bank," an investment bank, for a firm-commitment underwriting agreement. Global Capital Bank agrees to buy all 20 million shares of InnovateTech stock at $25 per share directly from the company. Global Capital Bank then attempts to sell these shares to its clients and other investors. Even if Global Capital Bank only manages to sell 18 million shares, it has already paid InnovateTech for all 20 million shares and bears the financial risk for the remaining 2 million unsold shares. This illustrates firm-commitment underwriting because Global Capital Bank committed to purchasing the entire issue, guaranteeing InnovateTech its desired capital, and assumed the risk of any unsold stock.

• Example 2: Corporate Bond Issuance for Expansion

  Consider "MegaCorp Manufacturing," an established company that needs to raise $500 million to build a new factory. Instead of issuing stock, they decide to issue corporate bonds. They engage "Apex Financial Group" for a firm-commitment underwriting. Apex Financial Group agrees to purchase all $500 million worth of bonds directly from MegaCorp at a predetermined price. Apex Financial Group then markets and sells these bonds to institutional investors and the public. Regardless of how quickly or completely Apex Financial Group sells the bonds, MegaCorp receives its full $500 million upfront. This demonstrates firm-commitment underwriting because Apex Financial Group guaranteed the funding to MegaCorp by committing to buy the entire bond issue, thereby taking on the market risk.

• Example 3: Municipal Bonds for Public Infrastructure

  A city, "Greenville," needs to fund a new public park and community center, requiring $100 million. Greenville decides to issue municipal bonds. They enter into a firm-commitment underwriting agreement with "Community Bank & Trust." Community Bank & Trust agrees to purchase all $100 million in municipal bonds from Greenville at a set interest rate and price. Community Bank & Trust then takes on the task of selling these bonds to individual investors, pension funds, and other financial institutions. Even if there's less demand than expected for the bonds, Greenville has already received its $100 million from Community Bank & Trust. This is a firm-commitment underwriting because Community Bank & Trust provided the city with guaranteed funding by buying the entire bond issue, assuming the risk of reselling them to investors.