Underwriting agreement: Overview, definition and examples
What is an underwriting agreement?
An underwriting agreement is a contract between a company (typically the issuer) and an underwriter (often a bank or financial institution) that outlines the terms and conditions under which the underwriter agrees to purchase securities, such as stocks or bonds, from the issuer. The underwriter may agree to sell these securities to investors, or they may purchase them outright, assuming the risk of reselling them.
In essence, the underwriting agreement defines the responsibilities of the underwriter, including the price at which securities will be offered, the commission they will earn, and any other terms related to the issuance of securities.
Why is an underwriting agreement important?
An underwriting agreement is crucial because it sets the foundation for a successful securities offering. It provides clarity on the pricing, timing, and terms of the offering, which can help ensure the company raises the needed capital while minimizing risk. For the underwriter, the agreement protects them by outlining their responsibilities and any financial risks they may face in reselling the securities.
For businesses, having an underwriting agreement in place is vital to ensure that the process of raising capital through securities is transparent and legally sound. It also helps prevent misunderstandings between the parties involved, such as the company and the underwriter, and protects both parties in case the offering doesn't go as planned.
Understanding underwriting agreements through an example
Imagine a tech startup looking to go public. The company hires an investment bank as its underwriter to help with the IPO (Initial Public Offering). The underwriting agreement will specify that the underwriter will purchase a set number of shares at an agreed-upon price and then resell them to the public. It will also define the fees the underwriter will receive, how the shares will be priced, and the obligations of both parties if the offering doesn’t perform as expected.
In another case, a real estate development company might use an underwriting agreement to sell bonds to investors. The underwriter in this case agrees to buy the bonds from the company and resell them to investors at a markup. The underwriting agreement will ensure that both parties understand the terms of the sale and outline how the underwriter is compensated.
An example of an underwriting agreement clause
Here’s how an underwriting agreement clause might look:
“The Underwriter agrees to purchase, and the Company agrees to sell, [number] of securities at the price of [price] per security, subject to the terms and conditions of this Agreement. The Underwriter will resell these securities to the public at a price of [offering price], and will receive a commission of [percentage] on the total sale.”
Conclusion
An underwriting agreement plays a crucial role in the process of raising capital, especially for companies looking to issue securities like stocks or bonds. It sets clear terms for both the issuer and the underwriter, ensuring that both parties understand their responsibilities and risks. By specifying details such as pricing, commission, and sale terms, it helps manage expectations and protects both parties from potential misunderstandings or financial loss.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.