Meaning
Underwriting of shares is an agreement where an underwriter guarantees to subscribe to the shares not taken up by the public in a share issue.
In simple words:
If the public does not buy all the shares, the underwriter will buy the remaining shares.
This ensures the company gets minimum subscription.
When a company issues shares to the public:
· There is a risk that the issue may not be fully subscribed.
· If minimum subscription is not received → issue fails.
To avoid this, companies appoint underwriters.
The person or institutions underwriting a public issue of shares and debentures are called underwriters.
The underwriters may be individuals, partnership firms, joint stock companies, banks and financial institutions. Ex : ICICI, SFC’s, LIC etc.,
Meaning of underwriting Commission.
The underwriters are entitled to some consideration for the risk they undertake in underwriting the shares or debentures of a public company. In the words the consideration payable to the underwriters for underwriting the shares and debentures is called underwriting commission.
Maximum Limit for underwriting commission.
For the services rendered by the underwriters : they are entitled to a maximum commission of 5% of the issue price of the shares and debentures at 2.5% on the issue price according to company’s act of 1956.
According to SEBI the maximum commission payable to underwriters for underwriting the shares and debentures is 2.5% of the issued price.
1️⃣ Guarantee of Minimum Subscription
The company is assured that even if the public does not subscribe fully, the underwriter will take up the remaining shares.
2️⃣ Reduces Risk of Failure of Issue
Prevents the issue from failing due to under-subscription.
3️⃣ Improves Public Confidence
Investors feel more confident when reputed financial institutions underwrite the issue.
4️⃣ Better Marketability of Shares
Underwriters use their expertise and networks to promote the issue.
5️⃣ Financial Stability
Company can plan its projects without fear of insufficient capital.
6️⃣ Expert Advice
Underwriters (usually banks or financial institutions) provide guidance regarding pricing and timing of the issue.
Types of Underwriting
On the basis of number of shares or debentures underwritten:
According to this basis underwriting contracts are classified in t 2 type they are,
a) Complete underwriting : It is one under which the whole of the issue of shares or debentures of a company is underwritten by one or more underwriters.
b) Partial Underwriting : It is one under which a part of the issue of shares or debentures of a company is underwritten by one or more underwriters.
On the basis of liability of underwriters: According to this basis underwriting contracts are classified into 2 types they are,
a) Pure / Open Underwriting :
it is an arrangement under which and underwriters or underwriters agree to take up the shares or debentures of a company only when the shares or debentures underwritten by him or them is not fully subscribed by the public.
b) Firm Underwriting : It is an arrangement where underwriters agrees to buy a definite number of shares and debentures irrespective o f the number of shares or debentures subscribed by the public. In case of firm underwriting, the underwriters gets priority over general public if shares / debentures are over subscribed.