Legal Definitions - strict underwriting

Strict underwriting refers to a financial arrangement where an investment bank or financial institution takes on a firm and significant obligation to ensure that a company successfully raises capital through the sale of new securities (like stocks or bonds). This typically means the underwriter commits to purchasing any securities that are not bought by other investors, thereby guaranteeing the issuer will receive the intended amount of funding. It is a robust form of underwriting that minimizes the financial risk for the company issuing the securities.

• Example 1: A company conducting a rights offering

  Imagine "Tech Innovations Inc." wants to raise $75 million by offering new shares to its existing shareholders (a rights offering). To ensure they secure the full amount, they engage an investment bank under a strict underwriting agreement. The bank agrees that if existing shareholders do not subscribe to all $75 million worth of shares, the bank will purchase any remaining unsold shares itself. This guarantees Tech Innovations Inc. will receive its $75 million, regardless of the participation rate of its current shareholders.

  This illustrates strict underwriting because the investment bank has made a firm commitment to ensure the full capital is raised, taking on the risk of any unsold shares.

• Example 2: A startup pursuing an Initial Public Offering (IPO)

  Consider "GreenEnergy Solutions," a promising but relatively new company, planning its Initial Public Offering (IPO) to raise capital for expansion. Due to its innovative but unproven technology, there's some market uncertainty about the exact level of investor demand. To provide certainty and ensure they secure the necessary funding, GreenEnergy Solutions enters into a strict underwriting agreement with a major investment bank. The bank commits to buying all the shares being offered to the public, even if public demand is lower than anticipated. The bank then takes on the responsibility of reselling these shares to investors.

  This is strict underwriting because the bank is taking on the full risk of selling all the shares, guaranteeing the startup receives its funding, which is particularly crucial for a company with a less established track record.

• Example 3: A large corporation issuing new bonds for a major infrastructure project

  "Global Logistics Corp." needs to raise $300 million to finance the construction of a new distribution hub. They decide to issue corporate bonds to achieve this. They hire an underwriter under a strict underwriting agreement. The underwriter agrees to purchase the entire $300 million bond issue directly from Global Logistics Corp. at a predetermined price. The underwriter then assumes the responsibility of selling these bonds to institutional investors and the broader market.

  This demonstrates strict underwriting because the underwriter has firmly committed to buying the entire bond issue, providing Global Logistics Corp. with immediate and guaranteed access to the $300 million, irrespective of how quickly the bonds are subsequently resold to other investors.