What Is Best Efforts
Best efforts is a service agreement to make the best effort possible to fulfill the requirements of the contract, without promising a specific outcome. In finance, it is a contractual term in which an underwriter promises to make its best effort to sell as much of a securities offering (e.g., IPO) as possible. Best-effort agreements are used mainly for securities in a less-than-ideal market condition or with higher risk, such as an unseasoned offering.
- Best efforts is a term for a commitment from an underwriter to make their best effort to sell as much as possible of a securities offering.
- It is also a general service agreement term used in place of a firm deliverable commitment.
- The opposite is a firm commitment, or bought deal, in which the underwriter buys all shares or debt and has to sell it all to make money.
Understanding Best Efforts
Best efforts relieve underwriters from responsibility for any inventory of shares they are unable to sell. The underwriter does not guarantee that it will sell the entire IPO issue in a best-efforts agreement. A best-efforts agreement limits both the underwriter's risk and the underwriter's profit potential since they generally receive a flat fee for their services.
In a best-efforts offering, the investment bank acts as an agent putting forth its best effort to sell the stock issue. The investment bank does not entirely buy the securities available to the public. Instead, the bank has an option to purchase only those shares that are sufficient to meet client demand. Alternatively, the bank can cancel the entire issue and forfeit the fee.
Best-efforts offerings sometimes contain conditions, such as all-or-none and part-or-none. All-or-none offerings require the entire offering to sell for the deal to close. With a part-or-none offering, only a set amount of securities qualify to close the deal.
Under the Financial Industry Regulatory Authority's (FINRA) SEA Rule 10b-9, investor funds must be returned promptly if contingency offerings are not realized.
Best Efforts vs. Firm Commitment
Underwriters and issuers can handle public offerings in different ways. In contrast to a best-efforts agreement, a bought deal, also known as a firm commitment, requires the underwriter to purchase the entire offering of shares. The underwriter's profit is based on how many shares or bonds it sells, and on the spread between their discounted purchase price and the price at which they sold the shares.
Best Efforts Example
In September 2015, Aperion Biologics Inc. filed an offering statement on Form 1-A with the Securities and Exchange Commission (SEC) to sell $20 million in an initial public offering. The agent, WR Hambrecht+ Co., employed a best efforts approach to selling the Aperion shares.
As defined in the Jumpstart Our Business Startups Act (JOBS), Aperion is a small company qualifying as an emerging growth company. For the fiscal year ending Sept. 30, 2015, revenue was $34,000. Considering the Aperion's small size, WR Hambrecht chose to underwrite a best-efforts offering to minimize their risk by not selling the shares.
The January 2016 filing registered 3.1 million Aperion shares, and the proposed price range of $7-$9, with the shares offered on an all-or-none basis.