An initial public offering (IPO) underwriter is typically a large investment bank that works closely with a company to issue stock on the public markets. They are almost always IPO specialists who work for an investment bank.
Underwriters can also be financial professionals that evaluate risk and then determine a price for financial transactions such as purchasing an insurance policy or taking out a mortgage.
In the world of equities, underwriters work with private companies to value their operations, connect with potential investors, and issue stock on a public exchange for the first time.
What Is an IPO Underwriter?
Stock underwriters guide the company that’s issuing stock through the IPO process, making sure they satisfy all of the regulatory requirements imposed by the Securities and Exchange Commission (SEC), as well as the rules imposed by the exchange, such as the Nasdaq or the New York stock Exchange (NYSE).
Recommended: What Is an IPO?
Role and Benefits of an IPO Underwriter
Aside from the fact that an underwriter is required during the IPO process, there are many benefits to this role. An IPO’s underwriter helps create the market for the stock by contacting a wide range of institutional investors, including mutual funds, insurance companies, pension funds and more.
Key Functions of an IPO Underwriter
They first reach out to this network of investors to gauge their interest in the company’s stock, and to see what those investors might be willing to pay. The underwriter uses those conversations to set the price of the IPO.
From there, the underwriter of an IPO works with the company issuing the stock through the many steps that lead up to its IPO. On the day of the IPO, the underwriter is responsible for purchasing any unsold shares at the price it set for the IPO.
The way that IPO underwriters get paid depends on the structure of the deal. Typically, IPO underwriters buy the entire IPO issue and then resell the stocks, keeping any profits, though in some cases they receive a flat fee for their services.
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What Is IPO Underwriting?
An IPO is the process through which a private company “goes public”, and has its shares sold to regular investors on a public market. The company issuing stock works with the IPO underwriters throughout the process to determine how to price their stock and stir interest among potential investors.
Most companies find their way to the investing public through a group of underwriters who agree to purchase the shares, and then sell them to investors. But only a few broker-dealers belong to this “underwriting syndicate,” and some of them sell exclusively to institutional investors.
What Does an IPO Underwriter Do?
In essence, an underwriter in an IPO is the intermediary between a company’s executives and owners, such as venture capitalists, seeking to issue shares of stock and public-market investors.
When a company seeks funding from the capital markets, it must make dozens of decisions. How much money does the company want to raise? How much ownership will it cede to shareholders? What type of securities should it issue? Those are just a few, including what kind of relationship the company wants to have with its underwriter.
Underwriting agreements take different forms, but in the most common agreement, the underwriter agrees to purchase all the stock issued in the IPO, and sell those shares to the public at the price that the company and the underwriter mutually agree to. In this agreement, the underwriter assumes the risk that people won’t buy the company’s stock.
Sometimes a company works with a group of underwriters, who assume the risk, and help the company work through the many steps toward an IPO. This involves issuing an S-1 statement. This is the registration form that any company needs to file with the SEC to issue new securities.
The S-1 statement is how companies introduce themselves to the investing public. S-1 requires companies to lay out plans for the money they hope to raise. The IPO underwriter also creates a draft prospectus for would-be investors.
💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.
What Qualifications Does an IPO Underwriter Need?
Underwriters work in many roles across the finance sphere. You could be a mortgage underwriter, assessing the creditworthiness of certain borrowers. You could work in the insurance industry. Becoming an IPO underwriter, and bringing private companies into the public marketplace, requires understanding how businesses work, and how the equity markets function.
At minimum an IPO underwriter needs a Bachelor’s degree, but it helps to have certain other skills and experience. For example, would-be underwriters might consider a background in economics as well as math. Underwriters generally need good analytical, communication, and computer skills.
Educational and Professional Requirements
There are a number of certifications that apply in the underwriting field in general, but there isn’t a specific designation for IPO underwriters. It’s more common for someone who wants to work with IPOs to get their Masters in business administration (MBA), and from there to work at an investment bank.
The IPO Underwriting Process
Underwriting an IPO can take as little as six months from start to finish, though it often takes more than a year. While every IPO is unique, there are generally five steps that are common to every IPO underwriting process.
Step 1. Selecting an Investment Bank or Broker Dealer
The issuing company selects an underwriter, usually an investment bank. It may also select a group or syndicate of underwriters. In that case, one bank is selected as the lead, or book-running, underwriter.
One kind of agreement between the issuing company and the underwriter is called a “firm commitment,” which guarantees that the IPO will raise a certain sum of money. Or they may sign a “best efforts agreement,” in which the underwriter does not guarantee the amount of money they will raise. They may also sign in “all or none agreement.” In this agreement, the underwriter will sell all of the shares in the IPO, or call off the IPO altogether.
There is also an engagement letter, which often includes a reimbursement clause that requires the issuing company to cover all the underwriter’s out-of-the-pocket expenses if the IPO is withdrawn at any stage.
Step 2. Conduct Due Diligence and Start on Regulatory Filings
The underwriter and the issuing company then create an S-1 registration statement. The SEC then does its own due diligence on the required details in that document. While the SEC is reviewing it, the underwriter and the company will issue a draft prospectus that includes more details about the issuing company. They use this document to pitch the company’s shares to investors. These roadshows usually last for three to four weeks, and are essential to gauging the demand for the shares.
Step 3. Pricing the IPO
Once the SEC approves the IPO, the underwriter decides the effective date of the shares. The day before that effective date, the issuing company and the underwriter meet to set the price of the shares. Underwriters often underprice IPOs to ensure that they sell all of their shares, even though that means less money for the issuing company.
Step 4. Aftermarket Stabilization
The underwriter’s work continues after the IPO. They will provide analyst recommendations, and create a secondary market for the stock. The underwriter’s stabilization responsibilities only last for a short period of time.
Step 5. Transition to Market Competition
This final stage of the process begins 25 days after the IPO date, which is the end of the “quiet period,” required by the SEC. During this period, company executives can not share any new information about the company, and investors go from trading based on the company’s regulatory disclosures to using market forces to make their decisions.
After the quiet period ends, underwriters can give estimates of the earnings and stock price of the company.
Some companies also have a lock up period before and after they go public, in which early employees and investors are not allowed to sell or trade their shares.
The IPO underwriter, typically a large investment bank, plays a vital role in the process of taking a company public.
They help to guide the company through the many hurdles required to go public, including making sure the fledgling company meets all the criteria required by regulators and by the public exchanges. The IPO underwriter helps drum up investor interest in the new company and thereby setting the initial valuation for the stock.
IPOs are an important part of the stock market, and they present an opportunity for investors to get in on a company that may be entering a growth phase by allowing them to buy IPO stocks.
Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.
What are the responsibilities and duties of an IPO underwriter?
IPO underwriters have numerous responsibilities. They not only shepherd the private company through the IPO process, they reach out to institutional investors and mutual funds to gauge interest and set the initial price of the stock. They buy the securities from the issuer, and sell the IPO stock to investors via their distribution network.
Can multiple underwriters be involved in an IPO
Yes. Sometimes more than one underwriter is required to help a company meet all the criteria set by the SEC and by the public exchanges.
What criteria do companies consider when selecting an IPO underwriter?
The experience and reputation of the underwriter is an important criteria companies use when establishing this relationship.
Can the performance of an IPO underwriter impact the success of the IPO?
Yes. Some industry data suggests that the better an underwriter’s reputation, the more accurate the initial pricing is, and the less likely there will be long-term underperformance.
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Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.
New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.
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