What Is a Backstop Purchaser?
When called upon, a backstop purchaser functions as a form of insurance. In exchange for a fee, they provide security, guaranteeing that all of the newly issued shares will be purchased. In other words, the company behind the issue can be sure of fulfilling its fundraising requirements, regardless of open market activity.
- A backstop purchaser is an entity that agrees to purchase all the remaining, unsubscribed securities from a rights offering.
- In exchange for a fee, they guarantee companies that their capital requirements will be met.
- Backstop purchasers are usually called on after other underwriting parties have failed to sell all of the shares at a discount to the public.
- They don’t come cheap and tend to charge a premium for the risks they take on.
How a Backstop Purchaser Works
Backstop purchasers are a form of standby underwriting, where one or more investment banks enter into an accord with a company and agree to publicly sell any of its unsubscribed shares for a price generally no less than the subscription price associated with the rights offering. In the case of backstop or standby purchasers, the party agrees to go a step further and buy all of the leftover, unsubscribed shares themselves.
The backstop purchase generally comes after three preceding rounds of rights offering. In the first round, the company offers existing shareholders the opportunity to purchase its stock at a discount to the market price. In the second round, it will proceed to offer its investors the right to buy any additional shares that remain unsubscribed. Then, in the third round, the company enters into an underwritten agreement, where one or more underwriters have agreed to purchase any shares not taken up in the rights offering, including in the oversubscription, for resale to the public.
The New York Stock Exchange (NYSE) views this round as a public offering for cash only if marketing efforts are made to a large group of potential purchasers and if shares are bought by a least some of these potential buyers. If, after all these options have been exhausted, there are still no takers, a fourth-round kicks in, during which backstop purchasers are permitted to buy up to 19.9% in the aggregate of the shares of common stock prior to the rights offering.
Backstop purchasers are usually called on after other underwriting parties have failed to sell all of the shares at a discount to the public.
Rights offerings are considered normal business practices and are not subject to shareholder approval. Insured rights offerings differ somewhat, with their additional fundraising rounds attracting scrutiny.
Backstop Purchaser Requirements
Backstop purchasers may face constraints, however, if they are related parties: directors, officers, five-percent shareholders, or any person or company affiliated with those position-holders. Should one or more substantial investors agree to act as a backstop purchaser, they are not allowed to engage in activities to mitigate the risk of an under‐subscription, nor charge a fee.
In addition, if the related party wants to participate in other rounds of the offering, they must sit out one of the rounds. They are also required to buy the shares in the standby purchase on the same terms offered to existing shareholders in the rights offering.
Advantages and Disadvantages of a Backstop Purchaser
An issuer might consider a standby offering and backstop purchaser if they need to raise a specific amount of capital. That said, when calculating the number of share sales necessary to bring in the required funds, an issuer should factor backstop fees into the offering amount.
Backstopping can be costly and backstop purchases are often paid a premium in return for the risks they take on. For instance, in 2006, when Warren Buffett's Berkshire Hathaway Inc. (BRK.B) acted as a backstop purchaser for building materials company USG Corp. (USG), it earned a non-refundable fee of $67 million for the service.
Backstop compensation is generally a flat standby fee plus a per-share amount.
An issuer might also consider a standby rights offering if the stock price is volatile. Because the offering period is anywhere from 16 to 45 days, shareholders have plenty of time to decide whether they will exercise their rights and subscribe based on the price of those shares trading in the market, which could be the same or less than the subscription price.
The issuer doesn't want to set the subscription price too low but must consider the possibility that shareholders will balk. A backstop purchaser is an attractive mitigating force in this event.