Firm Commitment Offerings
Investment banks distribute most IPOs in firm commitment offerings. With a firm commitment offering, the investment bank commits its capital to purchase IPO shares. Once the offering price is set, the bank purchases the shares at the offer price less a spread, or discount. The bank then sells the securities to investors. In practice, the investment bank lines up a number of investors to purchase the shares before the offering date. The spread represents the investment bankís profit from reselling each share at the offering price. The issuer has virtually zero price risk in a firm commitment offering once the offer price is set. The issuer receives the proceeds from the sale immediately, which it can then spend as outlined in the prospectus. The investment bank carries, or underwrites, the risk of fluctuating stock prices. Should the marketís perception of the issuer change or a macroeconomic event result in a stock market decline, the investment bank carries the risk of loss, or at least the possibility of a smaller than expected spread. For most firm commitment underwritings, the managing investment bank arranges investment banking syndicates to help distribute shares of the newly public firm. The managing investment bank makes a smaller spread, or profit, from selling shares to syndicate members.