A bought deal is financial
underwriting contract In investment banking, an underwriting contract"The Investment Banking Handbook" by J. Peter Williamson, 1988, ""Underwriting Contracts", p. 128/ref> is a contract between an underwriter and an issuer of securities.
The following types of underwri ...
often associated with an
initial public offering
An initial public offering (IPO) or stock launch is a public offering in which shares of a company are sold to institutional investors and usually also to retail (individual) investors. An IPO is typically underwritten by one or more investment ...
or
public offering
A public offering is the offering of securities of a company or a similar corporation to the public. Generally, the securities are to be listed on a stock exchange. In most jurisdictions, a public offering requires the issuing company to publish a ...
. It occurs when an
underwriter
Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liabilit ...
, such as an
investment bank
Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort.
In finance, the purpose of investing is ...
or a syndicate, purchases
securities
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
from an
issuer
Issuer is a legal entity that develops, registers, and sells securities for the purpose of financing its operations.
Issuers may be governments, corporations, or investment trusts. Issuers are legally responsible for the obligations of the issu ...
before a preliminary prospectus is filed. The underwriter acts as
principal rather than
agent
Agent may refer to:
Espionage, investigation, and law
*, spies or intelligence officers
* Law of agency, laws involving a person authorized to act on behalf of another
** Agent of record, a person with a contractual agreement with an insuranc ...
and thus actually "goes long" in the security. The bank negotiates a price with the issuer (usually at a discount to the current
market price
A price is the (usually not negative) quantity of payment or Financial compensation, compensation given by one Party (law), party to another in return for Good (economics), goods or Service (economics), services. In some situations, the pr ...
, if applicable).
The advantage of the bought deal from the issuer's perspective is that they do not have to worry about financing risk (the risk that the financing can only be done at a discount too steep to market price.) This is in contrast to a
book building
Book building is a systematic process of generating, capturing, and recording investor demand for shares. Usually, the issuer appoints a major investment bank to act as a major securities underwriter or bookrunner.
Book building is an alternativ ...
or fully marketed deal, where the underwriters have to "market" the offering to prospective buyers, only after which the price is set.
Advantages and disadvantages
The advantages of the bought deal from the underwriter's perspective include:
# Bought deals are usually priced at a larger discount to market than fully marketed deals, and thus ''may'' be easier to sell; and
# The issuer/client may only be willing to do a deal if it is bought (as it eliminates execution or market risk.)
The disadvantage of the bought deal from the underwriter's perspective is that if it cannot sell the securities, it must hold them. This is usually the result of the market price falling below the issue price, which means the underwriter loses money. The underwriter also uses up its capital, which would probably otherwise be put to better use (given sell-side investment banks are not usually in the business of buying new issues of securities).
See also
*
Bought out deal
*
Private placement
Private placement (or non-public offering) is a funding round of securities which are sold not through a public offering, but rather through a private offering, mostly to a small number of chosen investors. Generally, these investors include friend ...
References
Banking
Initial public offering
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