What is Best Efforts Underwriting?

Best efforts underwriting is a way for companies to sell new stocks or bonds. The company hires one or more banks or brokerage firms to help them. These firms are called the underwriting syndicate.

The Underwriting Syndicate’s Job

The underwriting syndicate tries very hard to sell as much of the new securities as they can to investors. They make phone calls, send out information, and meet with potential buyers. The syndicate really wants to sell everything, but they don’t have to.

No Guarantees

In best efforts underwriting, the underwriting syndicate does not make any promises. They don’t sign a contract saying they will buy any stocks or bonds that are left over. The company hopes the syndicate can sell it all, but there are no guarantees.

How is Best Efforts Underwriting Different?

There are other ways for companies to sell new securities. One common way is called firm commitment underwriting. Best efforts is different from firm commitment in an important way.

Firm Commitment Underwriting

In firm commitment deals, the underwriting syndicate does make a promise. They agree to buy all the new stocks or bonds from the company. Then they sell them to investors. If any are left over, too bad. The underwriters have to keep them.

Why the Difference Matters

For the company, firm commitment is less risky. They know they will get all the money they wanted. Best efforts means they might get less money than they hoped for.

For the underwriting syndicate, best efforts is less risky. They don’t have to worry about getting stuck with securities they can’t sell. Firm commitment means they could lose money.

When Do Companies Use Best Efforts?

Companies will often use best efforts underwriting in certain situations. Usually, it depends on the company and on the market.

Smaller or Newer Companies

Big, well-known companies can usually get firm commitment deals. Investors trust them. Their stocks and bonds are easier to sell. Smaller or newer companies might have to use best efforts. Underwriters see them as more risky.

Volatile Markets

The stock and bond markets go up and down. When things are calm, underwriters are more willing to do firm commitment deals. When markets are crazy, they prefer best efforts. They don’t want to get stuck with securities if the market crashes.

The Best Efforts Process

Here is what usually happens in a best efforts underwriting deal:

The company decides to issue new securities. It might be common stock, preferred stock, or bonds.
The company hires one or more investment banks to be the underwriting syndicate.
The company and the syndicate agree on the price for the new securities. They also decide how long the syndicate will have to sell them. This is called the offering period.
During the offering period, the underwriters contact investors. They try to get investors to commit to buying the securities.
Money from investors goes into an escrow account. The money stays there until the deal closes.
If enough securities are sold, the deal closes. The company gets the money (minus the underwriters’ fees). Investors get their securities.
If not enough securities are sold, the deal might not close. The company doesn’t get any money. Investors get their money back.

Pros and Cons of Best Efforts

Like anything else, best efforts underwriting has both good and bad points. Companies have to weigh these when deciding what type of underwriting to use.

Advantages for Companies

Can still raise money even if the whole offering doesn’t sell
Don’t have to pay underwriters for any unsold shares
Good option for smaller companies or risky offerings

Disadvantages for Companies

Might not raise as much money as they want
If deal fails, it looks bad for the company
Have to pay underwriters’ fees even if the deal fails
Money is tied up in escrow until deal closes

Advantages for Underwriters

Don’t have to buy any unsold securities
Less risk than firm commitment deals

Disadvantages for Underwriters

Might make less money in fees than firm commitment
Reputation can suffer if they fail to sell the securities