Question

A company issues a $200 million IPO. The offer price is $5 per share. The underwriter’s spread is 8%. The underwriter has agreed to a stand-by arrangement. For issuing the IPO, the company will pay some admin costs. The admin costs include a legal fee of $50,000, an accountant fee of $30,000 and other admin costs amounting to $170,000. The company’s share price increases by 10% at the end of the first day of trading. However, the offer has not been as successful as expected, and only 95% of the shares have been sold.

1. Determine the company’s total cost of issuing the securities.
2. Determine proceeds available to the underwriter and to the issuer.   
3. How will the proceeds available to underwriter change for a best-effort arrangement?
4. If the arrangement was best-effort instead of stand-by, who would have borne more risk? The underwriter or the issuer? Why?

Answer 1

a) Total Cost = Legal Fee + Accountant Fee + Other + Spread paid to the underwiter = 50,000+30,000+170,000+8% * 200m * 5 = 80.25million

b) Issuer Proceeds = 0.92 * 200million * 5 = 920 million

Underwriter Proceeds = 80million - 0.05 * 200m * 5 = 30million

c) For best effort arrangement, the underwiter will not have to pay for the IPO not fully subscribed. The underwriter will be elligible for the fees ie 80million but will not have to pay the shortcoming of 50million.

d) The issuer will bear more risk in the best effort approach. In the best effort approach, if the IPO is not fully subsribed then the issuer will not get the capital he wants. In this case he would have gotten only 920-50 = 870million

So issuer has more risk in the best effort approach.