What is an Underwriting Syndicate?
Equity underwriters primarily look after the issue and distribution of securities to the investors on behalf of a corporation or any other issuing unit. These underwriters or groups of underwriters have an important role to play in the entire process of new issues or IPO of a company. They help decide the initial offering price of the securities, be it common stock or preference shares. They purchase the entire securities from the issuer. And then, they sell these securities to investors through their own network. An Underwriting syndicate constitutes several investment banks and commercial banks that have formed a group to sell new securities- be it equity, debt, or both, to investors and the public at large.
Generally, such arrangements are temporary in nature. A lead undertaker creates and leads such a syndicate for the issuance of the securities. These syndicates are also known as “Underwriting Group” and “Banking Syndicate.”
- What is an Underwriting Syndicate?
- How do Underwriting Syndicates work?
- The structure of an Underwriting Syndicate
- Importance of Underwriting Syndicates
The creation of an Underwriting syndicate is done when the issue size of the securities is too big for a single investment bank or underwriter to handle and where the lead manager would like to limit his risk in case of failure. The main purpose is to utilize the resources and expertise of multiple banks and work together to make the new issue a success. This will also lead to the division of risk and rewards amongst the participating bodies. The dissolution of such syndicates happens after the sale activities for the securities get over.
How do Underwriting Syndicates work?
The primary role of the syndicate or Investment and commercial banks is to act as an active intermediary. This role play happens between the issuing company and the investing public or institution. They have adequate financial capacity in between them as they are working in a team. They are in a position to pay for the entire issue upfront to the company. The company is free from the tension of selling the issue directly to retail and institutional investors, that too in parts. An underwriting syndicate relieves the company from the risk of unsold inventory or under-subscription of its stock.
The risk-sharing also minimizes any potential downsides for the underwriting syndicate from the new offer. They are able to get the securities at a discount from the company. Because the Syndicate purchases the entire lot and bears the risk of sale as well. Hence, the syndicate makes considerable gains from its investing and risk-taking activities.
The profits that an underwriting syndicate makes are known as the “Underwriting spread.” It is the difference between what the syndicate pays to the issuing company and the price at which it sells the issue to the investors. The lead underwriter assumes the greater risk for the issue. And hence has a larger share in the quantum of securities, in the underwriting spread, and other fees. It is also responsible for the successful issue of the IPO as well as the process of due diligence. Other members of the syndicate will receive a smaller share as per the terms of the arrangement.
The structure of an Underwriting Syndicate
A large Underwriting syndicate has a structure similar to a pyramid. The lead underwriter, along with a few co-lead managers, is at the top of the syndicate. They have the entire responsibility for the smooth execution and completion of the entire IPO process right. The IPO process starts right from deciding the pricing and timing, preparation, validation, and filing of documents and obtaining necessary approvals, collecting bids and subscriptions, and finally allotment and distribution of the security to the investors. They are in control of most of the aspects of the issue and decide how much other co-managers and banks will be selling. Lead Underwriter is the most cherished slot in an underwriting syndicate, and banks fight to grab it.
There remain many banks and co-managers at the intermediate and bottom levels who work according to the responsibilities allocated to them in the agreement. Their selection happens according to their abilities to provide due analysis and research, market-making capacity, and distribution network.
Importance of Underwriting Syndicates
Avoiding Risk and Uncertainty for the issuer
For the implementation and execution of projects, every company needs funding. And it is not possible all the time to fund it from its limited resources. Hence, they have no option but to approach the investors and the public at large to source the necessary capital. Therefore, IPO remains the only important route through which the organizations and institutions can garner risk-free funding. IPO is the first offering of common shares to the general public on a stock exchange by a company. The risk of the issuing company becomes minimum by deploying the services of an Underwriting Syndicate for the issue. The syndicate will purchase the entire issue at one go, pay for it upfront, and take care of its sale. Thus, the issuer with this arrangement gets the funds and focuses on business operations rather than worrying about the risk and uncertainty of IPO.
Seamless flow of information
Since the underwriting syndicate members are experts in their respective fields, they have an unhindered flow of useful information. It helps to maximize the symmetry of information among the members during the process of the IPO. Transparency is the key to the IPO process; hence, proper, concise, and correct information sharing timely remains an important part of the success of any IPO. Effective communication about the issue to the prospective investors is also the key to the big opening and successful subscription of an IPO. The Syndicate remains responsible and does all that is needed for the successful marketing of the issue. In other words, all this activity is effectively managed by the syndicate team.
Sharing of risks and responsibilities
An Underwriting syndicate bears a lot of risk in case of a new issue. If the issue is not sold out fully, the members of the syndicate have to hold the securities with them as per the terms of the agreement. This leads to the blockage of scarce capital and resources. Also, there is a risk of a fall in the price of the securities due to non-subscription. The formation of a syndicate divides this risk among the members. On the other hand, if a single underwriter is in-charge of the entire issue, he will have to bear the risk of failure and under-subscription alone.
A syndicate also helps to divide the work responsibilities among the members. This is especially helpful if the issue at hand is difficult and complex to manage alone. Together, they act as a big sales team with a deep reach to different types of investors and areas.
Flexibility in size of an Underwriting Syndicate
The size of an Underwriting Syndicate is not fixed. There is flexibility in the number of members in a syndicate as per the size of the issue in monetary terms, type of investor, economic conditions, risk, and specific requirements of the issue, if any. Hence, the lead underwriter need not worry and add more members to the syndicate as per requirement. Banks with better financial analysts have a greater chance of being selected first. Thus, a syndicate benefits from rich and diversified knowledge coming from the resources of multiple banks.
IPO is an essential part of risk-free fundraising for a company or institution. Underwriters or Underwriting Syndicate is an important intermediary in the process. Their involvement leaves the issuer with all the worries of marketing and arranging funds and all the efforts for a successful IPO. This job of selling the securities is done by these underwriting syndicate, who also take risks on their own in case of any unsold stock of security. The syndicate remains temporary and for a particular issue. Hence, the composition, numbers, etc., all remain flexible and decided on a case-to-case basis by the Lead Underwriter.