Best efforts underwriting is a type of securities underwriting agreement in which the underwriter, typically an investment bank, agrees to use its best efforts to sell as much of the securities offering as possible but does not guarantee the sale of the entire issue. Unlike a firm commitment underwriting, the underwriter does not purchase the securities outright and assumes no financial liability if some of the securities remain unsold.

Understanding best efforts underwriting is crucial for companies looking to raise capital and for investors participating in public or private securities offerings.

Understanding Best Efforts Underwriting

In a best efforts agreement, the underwriter acts as an agent for the issuing company rather than as a principal. The underwriter’s role is to market and sell the securities to investors on behalf of the company. Any unsold securities remain the responsibility of the issuing company, which bears the risk of not raising the full amount of intended capital.

Key Features:

1. No Guarantee: The underwriter does not guarantee that all securities will be sold.
2. Marketing Role: The underwriter focuses on promoting and distributing the offering to potential investors.
3. Issuer Risk: The issuing company assumes the risk of unsold securities.
4. Lower Fees: The underwriter typically charges lower fees compared to firm commitment underwriting.

Best efforts underwriting is often used by smaller or riskier companies that may not attract a broad investor base, or in markets where demand is uncertain.

Types of Best Efforts Underwriting

1. All-Or-None (AON)
   • The underwriter agrees to sell all the securities or none at all.
   • If the entire issue is not sold, the offering is cancelled, and funds are returned to investors.
2. Mini-Maxi Offering
   • A minimum and maximum number of securities to be sold are specified.
   • If the minimum threshold is not met, the offering is cancelled.
3. Partial Sale
   • The underwriter sells as many securities as possible without a requirement to reach a specific minimum.

Advantages of Best Efforts Underwriting

1. Lower Costs for Issuers: Fees paid to the underwriter are lower than in firm commitment agreements.
2. Flexibility: The issuer retains control over unsold securities.
3. Reduced Risk for Underwriter: The underwriter does not bear financial liability for unsold shares.
4. Access to Capital: Provides an opportunity for smaller or less established companies to raise funds.

Disadvantages of Best Efforts Underwriting

1. Issuer Risk: The issuing company bears the risk of unsold securities, potentially failing to raise the intended capital.
2. Uncertain Outcome: No guarantee that the entire offering will be sold.
3. Lower Investor Confidence: Investors may perceive less commitment from the underwriter, leading to reduced confidence in the offering.
4. Potential Delays: If the offering fails to meet minimum thresholds, the process may be delayed or cancelled.

When to Use Best Efforts Underwriting

1. Smaller Companies: Businesses without established track records may rely on best efforts underwriting to reduce costs and access capital.
2. Riskier Offerings: Used for securities that may have limited market demand.
3. Uncertain Market Conditions: Provides flexibility in situations where market conditions are volatile or unpredictable.
4. Private Placements: Frequently used in private offerings to accredited investors.

Step-by-Step Process of Best Efforts Underwriting

1. Agreement with Underwriter
   • The issuing company and underwriter negotiate terms, including the fee structure and sale responsibilities.
2. Due Diligence
   • The underwriter conducts due diligence to evaluate the company’s financials, prospects, and risks.
3. Marketing the Offering
   • The underwriter markets the securities to potential investors through roadshows, presentations, and promotional materials.
4. Book-Building
   • The underwriter collects indications of interest from investors to determine demand for the securities.
5. Sale of Securities
   • The underwriter sells as many securities as possible, adhering to the agreed terms (e.g., AON or mini-maxi).
6. Unsold Securities
   • Any securities not sold remain with the issuer, and the underwriter has no further obligations.
7. Final Settlement
   • Funds raised are delivered to the issuer, and the underwriter receives its fees or commission.

Practical and Actionable Advice

• Evaluate Market Conditions: Use best efforts underwriting in uncertain markets or for securities with niche appeal.
• Set Realistic Goals: Work with the underwriter to establish achievable sales targets.
• Choose the Right Underwriter: Select an experienced underwriter with a strong network of investors.
• Prepare Thoroughly: Ensure comprehensive due diligence and marketing to maximise the success of the offering.
• Consider Alternatives: If the risk of unsold securities is too high, explore firm commitment underwriting or private placements.

FAQs

What is best efforts underwriting?
Best efforts underwriting is an agreement where the underwriter commits to selling as many securities as possible without guaranteeing the sale of the entire offering.

How is it different from firm commitment underwriting?
In firm commitment underwriting, the underwriter buys the securities outright, guaranteeing the issuer full proceeds. In best efforts underwriting, the underwriter only acts as an agent and does not assume financial liability for unsold securities.

Who bears the risk in best efforts underwriting?
The issuing company bears the risk of unsold securities.

What are the types of best efforts underwriting?
The main types are all-or-none (AON), mini-maxi offerings, and partial sale agreements.

Why is best efforts underwriting used?
It is used by smaller companies or in uncertain markets to reduce underwriting fees and access capital.

What happens if the underwriter fails to sell all the securities?
Any unsold securities remain with the issuer, who may need to find alternative ways to sell or finance them.

Is best efforts underwriting common?
It is less common than firm commitment underwriting but is frequently used in private placements or by smaller issuers.

What are the advantages for issuers?
Issuers benefit from lower underwriting fees and flexibility in managing unsold securities.

What are the disadvantages for investors?
Investors may perceive greater risk or lower confidence in the offering compared to a firm commitment underwriting.

Can best efforts underwriting fail?
Yes, if the underwriter cannot generate sufficient interest, the offering may fail to raise the desired capital.

Conclusion

Best efforts underwriting is a cost-effective and flexible option for companies seeking to raise capital, especially in uncertain markets or for smaller offerings. While it reduces financial risk for underwriters, it places the burden of unsold securities on the issuer. By understanding the process, benefits, and challenges, both issuers and investors can make informed decisions about participating in best efforts underwriting agreements.