Firm commitment underwriting

In a firm commitment underwriting, the investment bank (underwriter) purchases the entire issue of securities directly from the issuer at an agreed price, then resells the securities to the public at the public offering price. The issuer is guaranteed its proceeds regardless of how the offering sells; the underwriter's profit is the spread between what it paid and what the public pays.

Because the underwriter takes ownership of the securities, it acts in a principal capacity and assumes the financial risk. If demand falls short and shares go unsold, the underwriter — not the issuer — absorbs the loss, either holding the leftover securities or selling them at a discount. For large offerings, several firms typically form a syndicate to share this risk.

The main alternative is best efforts underwriting, in which the underwriter acts as an agent, selling as much of the issue as it can without ever owning it — unsold securities are returned to the issuer, who bears the risk. Best efforts deals come in variations such as all-or-none (the entire issue must sell or the deal is canceled) and mini-max (a minimum amount must sell for the offering to proceed).

Underwriting commitments are a reliable topic on the SIE and Series 6 exams. The classic question asks who bears the risk of unsold shares: in a firm commitment the underwriter does, acting as principal; in a best efforts deal the issuer does, with the underwriter acting as agent.