Role of Underwriters in Business Financing
Underwriting is the process of setting the terms of a securities offering, such as interest, premiums, and the like, and verifying the buyer’s ability to finance them. Underwriters play a vital role in the government and corporate debt markets and the initial public offering (IPO) process, through which companies issue equity for the first time.
Underwriters are the entities who verify the legality of the securities being offered, in coordination with government agencies such as the US Securities and Exchange Commission. They also conduct due diligence on the company issuing the securities, ensuring that investors are aware of the financial state of the company.
In most cases, underwriters are financial institutions, most commonly, banks and investment firms. They assess the creditworthiness of the securities being offered and determine whether they’re sound investments, which can protect investors from taking on too much risk.
How Underwriting Works
Underwriting occurs during the issuing of securities, such as a bond or stock offering. Underwriters assess the financial risk of the offering through analysis of the issuer’s financial records and creditworthiness. Based on this assessment and other factors, they will confirm the offering price of the securities and make an underwriting agreement.
Underwriters also often purchase a portion of the securities being offered at the issuance price and resell them for a higher price to investors. They use a syndicate of broker-dealers, who purchase the securities from the underwriters and distribute them to individuals and funds.
Risks and Rewards of Underwriting
Underwriting can be a risky venture, as there is no guarantee the securities will be successfully sold. The underwriter may become liable for any losses incurred if the securities are not bought, which may run into millions of dollars. The rewards, on the other hand, can be substantial if the offering is successful, with the underwriters taking a commission on each sale.
In the case of an IPO, the underwriter’s role lies in mitigating the risks for investors, ensuring they know the financial condition of the issuing company, and determining the value of the securities. The underwriter can help set the offering price, which is important because it affects the amount of money the company will raise.
