Underwriting of Shares- Meaning and Real Life Examples
When investors want to know shares below rs 1 nse today, they deal with an existing investment, while companies use share issues to raise new capital. One important service that helps companies sell new shares is underwriting, which gives them greater confidence when offering shares to the public.
Underwriting plays an important role in the stock market because underwriting of shares connects companies that need funds with investors who want to buy securities. It also helps companies manage the risk of receiving fewer share applications than expected and supports a more reliable share issuance process.
What Is Underwriting of Shares?
Underwriting of shares is an agreement in which an underwriter promises to purchase or subscribe for a specified number of shares if the public does not buy them. The underwriter accepts this responsibility under agreed terms and usually receives a commission for the service. Companies use this arrangement when they issue new shares to collect money for business expansion, new projects, debt repayment, or other corporate needs. The agreement helps the company plan its fundraising because the underwriter takes responsibility for the portion covered by the contract.
For example, ABC Company offers 100,000 shares to the public at Rs. 50 each. If investors purchase only 80,000 shares, an underwriter who guarantees the entire issue may need to subscribe for the remaining 20,000 shares. This arrangement does not guarantee that the shares will perform well in the stock market after their issue. Instead, it provides financial support for the share subscription process and places certain responsibilities on the underwriter.
How Does Underwriting of Shares Work?
The process of underwriting of shares begins when a company decides to raise capital by issuing shares. It approaches an eligible underwriter, discusses the terms, and agrees on the number of shares covered, the commission, and the conditions that apply. After signing the agreement, the company offers shares to eligible investors who submit applications during the subscription period.
If investors subscribe to all the shares, the underwriting of shares may not need to purchase additional shares under an agreement covering only the unsubscribed portion. However, if the public buys fewer shares than offered, the underwriter must fulfill the remaining commitment according to the contract. This share underwriting process helps companies manage subscription risks and plan their fundraising activities more effectively.
Types of Underwriting of Shares
Companies can use different underwriting arrangements depending on their fundraising needs and the level of risk they want to cover. Understanding these types helps students and investors identify the responsibilities of the company and the underwriter.
Full Underwriting
Full underwriting is a type of underwriting of shares in which the entire share issue falls under an underwriting agreement. One underwriter or several underwriters accept responsibility for the whole issue according to their agreed commitments.
For example, a company offers 50,000 shares, and underwriters agree to cover all 50,000 shares. If the public subscribes to only 40,000 shares, the underwriters may need to cover the remaining 10,000 shares under the agreement. This full underwriting process helps companies reduce the risk of unsold shares and plan their fundraising more confidently.
Partial Underwriting
Partial underwriting is a type of underwriting of shares in which underwriters agree to cover only a specific portion of the shares offered by a company. The company remains responsible for arranging subscriptions for any shares that the underwriters have not covered.
For example, a company offers 100,000 shares, but the underwriting agreement covers only 60,000 shares. The underwriters accept responsibility for the covered portion, while the company must manage the remaining 40,000 shares under the offering arrangements. This partial underwriting process helps companies obtain some protection against unsold shares while retaining responsibility for the uncovered portion.
Firm Underwriting
Firm underwriting is a type of underwriting of shares in which an underwriter agrees to purchase a fixed number of shares regardless of public demand. This commitment differs from an agreement that covers only the shares left unsubscribed by the public.
For instance, an underwriter may agree to purchase 5,000 shares from a new issue. The underwriter must fulfill this commitment under the contract, although the treatment of these shares in liability calculations depends on the agreement and applicable rules. This firm underwriting agreement gives the company additional support when raising capital through a share issue.
Syndicate Underwriting
Syndicate underwriting involves two or more underwriters who share responsibility for a share issue. Companies may choose this approach when an offering is large or when one institution does not want to accept the entire commitment. Each underwriter accepts an agreed portion of the total issue. This arrangement distributes the financial risk among several participants and can help companies reach a wider group of investors.
Example of Underwriting of Shares
| Particulars | Number of shares |
|---|---|
| Total shares offered | 20,000 |
| Shares purchased by the public | 15,000 |
| Shares remaining unsubscribed | 5,000 |
| Shares covered by the underwriter | 20,000 |
| Shares the underwriter must take | 5,000 |
Calculation:
Shares left unsubscribed = Total shares offered − Shares purchased by the public
Shares left unsubscribed = 20,000 − 15,000 = 5,000 shares
Amount required = 5,000 × Rs. 100 = Rs. 500,000
This example shows how underwriting can help a company complete its share issue. Actual liability calculations may differ when several underwriters share the issue or when the agreement includes special conditions.
What Is Underwriting Commission?
| Particulars | Amount |
|---|---|
| Eligible underwriting amount | Rs. 1,000,000 |
| Commission rate | 2% |
| Underwriting commission | Rs. 20,000 |
Liability of an Underwriter
| Particulars | Shares |
|---|---|
| Gross underwriting commitment | 10,000 |
| Less: Applications credited | 7,000 |
| Net liability | 3,000 |
Advantages of Underwriting of Shares
Helps Companies Raise Capital
Companies need funds to expand operations, purchase equipment, develop products, or enter new markets. An underwriting agreement can help them plan the amount of capital they expect to raise from a share issue.
Reduces Subscription Risk
Investors may not always purchase every share offered to the public. An underwriting commitment can reduce the risk associated with unsold shares, provided the agreement covers that portion of the issue.
Supports Share Distribution
Underwriters may help organize and distribute new securities through the relevant offering process. Their involvement can support the company in reaching investors and managing the issue within the required rules.
Improves Fundraising Planning
A defined underwriting commitment helps a company understand how much of its issue has financial support. However, the company must still meet its own legal duties and should not treat underwriting as a guarantee of business success.
Disadvantages and Risks of Underwriting
Firm underwriting is a type of underwriting of shares in which an underwriter agrees to purchase a fixed number of shares regardless of public demand. Unlike ordinary underwriting, this arrangement requires the underwriter to fulfill a specific purchase commitment under the agreed terms.
For example, an underwriter may agree to purchase 5,000 shares from a new issue. The underwriter must fulfill this commitment according to the contract and applicable rules. This firm underwriting agreement provides additional support to the company when raising capital and helps define the underwriter’s responsibilities.
Underwriting of Shares in Pakistan
In Pakistan, the Securities and Exchange Commission of Pakistan (SECP) regulates underwriting as a securities activity. The SECP provides licensing requirements and regulatory information for underwriters and other participants involved in public offerings. The underwriting agreement sets out important details, including the size of the issue, the portion covered, the offer price, the commission, the duration of the agreement, and the process for subscribing to shares left unsubscribed. These terms help define the obligations of each party.
Companies and investors can consult the SECP’s official resources for applicable requirements. Because regulations can change, businesses should check the latest rules and seek qualified advice when preparing a real share offering.
Conclusion
Underwriting helps companies manage the risk of issuing new shares by placing a defined subscription commitment on an underwriter. It can support capital raising, share distribution, and fundraising planning, although it cannot guarantee market performance or eliminate every financial risk.
Companies should understand the types of underwriting, commission arrangements, and liability calculations before entering an agreement. Students can remember the central idea easily: an underwriter accepts responsibility for subscribing to an agreed portion of a share issue, including unsubscribed shares when the contract requires it.
