A back stop is an agreement between a financial institution and a company issuing shares, guaranteeing that any unsold shares during an IPO will be bought by the institution. Companies prefer institutions with support agreements to avoid unsold shares affecting share prices. Financial institutions can switch shares to a mutual fund or hold them for a period before selling on the open market. Companies should review an institution’s past agreements before selecting them for an IPO. It is important to consider fees and costs associated with the contract.
A back stop is a guarantee between a financial institution and the company for which it issues shares. The agreement assures the companies that the shares that were not sold during the initial public offering will be bought by the financial institution. For example, suppose a company decides to sell $40 million US dollars (USD) during its IPO. If $7 million of the shares remain unsold after the IPO process, the financial institution underwriting the sale must purchase the $7 million in accordance with the detainer agreement.
Going through an IPO is a slow and somewhat difficult process. Companies prefer financial institutions that offer support agreements to ensure that they will not have large amounts of unsold shares. One problem with unsold shares after the IPO process is that these shares may result in a decrease in the company’s share price, as the company may have to sell these shares at a discount. Existing shareholders who purchase shares during the IPO will have a loss on the share purchase.
Under a retroactive contract agreement, financial institutions that must purchase the shares of a company can switch the shares to a current mutual fund. The financial institution can also hold the shares for a certain period of time and then sell the shares on the open market. Depending on the number of shares of the underwriter, the sale of shares will likely be sold at various times. Selling too many shares at once will cause the share price to drop, causing the financial institution to lose money from the sales.
When selecting a financial institution to underwrite for an initial public offering, companies may decide to review the institution’s current and past agreements. This information provides a glimpse of how well the institution can sell shares through the IPO process. Underwriters who are unable to generate enough sales through an IPO may not receive the best clients, as people who review and rate a company’s stock tend to view poor IPO performance with some concern.
When entering into an emergency stop agreement, it is important to consider any fees or costs associated with the contract. Underwriters may charge more fees when making an IPO, as they may possibly be responsible for a large portion of the unsold shares. Charging an additional or higher IPO fee can help offset this possibility. The institution may also select a mix of safe and risky IPOs to diversify the overall risk associated with detention deals.
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