The term “gross spread” refers to an important element of the initial public offering (IPO) process: Gross spread is the money underwriters earn for their role in taking a company public.
When a company IPOs, or “goes public,” it releases its shares onto a public stock exchange, a massive undertaking that demands a tremendous amount of work behind the scenes. That work involves bankers, analysts, underwriters, and numerous others. All of that work must be compensated, which is where the gross spread comes into play.
Here’s what you need to know about the gross spread in the IPO process, also called the underwriting spread, and why it’s important.
How Gross Spread Works
The gross spread refers to the cut of the money that is paid to the underwriters for their role in taking a company public. In effect, it’s sort of like a commission paid to the IPO underwriting team. But the underwriting spread isn’t a flat fee, but a spread in the sense that it represents a share price differential.
Underwriters
Underwriters are common players in many facets of the financial industry. It’s common to find underwriters working on mortgages, as well as insurance policies.
When it comes to IPOs, underwriters or underwriting firms work with a private company to take them public, acting as risk-assessors, effectively, in exchange for the underwriters spread. Their job is to evaluate risk and charge a price for doing so.
The Role of Underwriters in the IPO Process
These IPO underwriters generally work for an investment bank and shepherd the company through the IPO process, insuring that the company covers all of its regulatory bases.
The underwriters also reach out to a swath of investors to gauge interest in a company’s forthcoming IPO, and use the feedback they receive to set an IPO price — this is a key part of the process of determining the valuation of an IPO.
In order to generate compensation for all this work, the underwriters typically buy an entire IPO issue and resell the shares, keeping the profits for themselves. So, the underwriters set the IPO price, buy the shares, and — assuming the shares increase in value once they become publicly available — the underwriters generate a profit from reselling them, the same way you would selling the shares of an ordinary stock that had risen in value.
For companies that are going public, the benefit is that they’re essentially guaranteed to raise money from the IPO by selling the shares to the underwriters. The underwriters then sell the shares to buyers they have lined up at a higher price in order to turn a profit. That difference in price (and profit) is the gross spread.
For the mathematically minded, the gross spread — basically the IPO underwriting fee — would be equal to the sale price of the shares sold by the underwriter, minus the price of the shares it paid for the shares.
Gross Spread & Underwriting Costs
The gross spread, for most IPOs, can range between 2% and 8% of the IPO’s offering price — it depends on the specifics of the IPO. There can be many variables that ultimately dictate what the gross spread ends up being.
The gross spread also comprises a few different components, which are divided up by members of the underwriter group or firm: The management fee, underwriting fee, and concession. The underwriters typically split the gross spread, overall, as such: 20% for the management fee, 20% for the underwriting fee, and 60% for the concession. More on each below:
Management fee
The management fee, or manager’s fee, is the amount paid to the leader or manager of the investment bank providing underwriting services. This fee essentially amounts to a commission for managing and facilitating the entire process. It’s also sometimes called a “structuring fee.”
Underwriting fee
The IPO underwriting fee is similar to the management fee in that it is collected by and paid to the underwriters for performing their services. Again, this is more or less a commission that is taken as a percentage of the overall gross spread and divided up by the underwriting teams.
Concession
The concession, or selling concession, is generally the compensation underwriters get for managing the IPO process for a company. So, in this sense, the concession is a part of the gross spread during the IPO process and is, effectively, the profits earned by selling shares when the process is complete. It’s divided up between the underwriters proportionately depending on the number of shares the underwriter sells.
Examples of Gross Spread
Here’s an example of how gross spread may look in the real world:
Company X is planning to IPO, and its shares are valued at $30 each. The underwriters working with Company X on its IPO purchase the full slate of shares prior to the IPO, and then go off and sell the shares at $32 each to investors and the general public.
In this case, the gross spread would be equal to the difference between what the underwriters paid Company X for the shares, and what they then sold the shares for to the public — $32 – $30 = $2.
Or, to express it as a ratio, the gross spread is 6.7%. More on the ratio calculation below.
Gross Spread Ratio
As mentioned, the gross spread can be expressed or calculated as a ratio. Using the figures above, we’d be looking to figure out what percentage $2 is (the gross spread) of $30 (the share price sold to the underwriters).
So, to calculate the ratio, you’d simply divide the gross spread by the share price — $2 divided by $30. The calculation would look like this:
$2 ÷ $30 = 0.0666
The figure we get is approximately 6.7%. Also note that the higher the ratio, the more money the underwriters (or investment bank serving as the underwriter) receives at the end of the process.
IPO Investing With SoFi
Though the gross spread, or underwriters spread, is not a well-known aspect of the IPO process, it’s relatively straightforward. Underwriters, who shepherd a company through the IPO process, ultimately buy the initial shares from the company at one price, and sell them to the public at the IPO at a higher price. The spread between the two is considered the gross spread, or the compensation the underwriting team earns for all their work.
The gross spread is usually between 2% and 8% of the IPO’s offering price, so it has some bearing on the initial stock price, but not in a way that impacts investors. If you’re interested in investing in IPOs, you can get started by opening an Active Invest account with SoFi Invest®. You can trade stocks, exchange-traded funds (ETFs), crypto, and more online, or using the app on your phone. Also, SoFi members have complimentary access to financial professionals, who can help answer your investing questions. Get started today!
FAQs
What is meant by the underwriting spread?
The underwriting spread is another term for the gross spread. Underwriters pay issuers, or an issuing company, for a company’s shares prior to the IPO. The underwriting firm then turns around and sells shares to investors. The difference (expressed as a dollar amount) that the underwriter pays the issuer and that it receives back from selling the shares during an IPO is the underwriting spread.
What are gross proceeds in an IPO?
Gross proceeds, in relation to an IPO, refers to the total aggregate amount of money raised during the public offering. This is all of the money raised by investors during the IPO.
What is a typical underwriting spread?
As underwriting spreads are usually expressed as dollar amounts, the typical underwriting spread can vary depending on several variables in the IPO process — including share price, share volume, etc. But in general, it can amount to between 3.5% and 7% of gross proceeds during an IPO.
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