What Is a Bought Deal?
A bought deal is a securities offering in which an investment bank commits to buy the entire offering from the client company. A bought deal eliminates the issuing company’s financing risk, ensuring that it will raise the intended amount. On the flip side, taking this approach, rather than pricing the offering via the public markets with a preliminary prospectus filing, usually results in the client firm getting a lower price.
- A bought deal occurs when an investment bank agrees to purchase an entire issue from the issuer, and then resell it after.
- A bought deal usually favors the issuing company in the sense that there is no risk to the financing—the company will get the money it needs.
- The investment bank takes on extra risk in carrying out a bought deal because it must be able to sell the securities—ideally for a profit.
- Bought deals essentially put the investment bank long the company stock while also tying up capital. In return for taking on this risk, the investment bank usually gets the securities at a discount to the projected market value.
Understanding Bought Deals
A bought deal is relatively risky for the investment bank. This is because the investment bank must turn around and try to sell the acquired block of securities to other investors for a profit. The investment bank assumes the risk of a potential net loss in this scenario, as the securities might lose value and sell at a lower price, or not sell at all.
To offset this risk, the investment bank often negotiates a significant discount when buying the offering from the issuing client. If the deal is large, an investment bank may team up with other banks and form a syndicate, so that each firm bears only a portion of the risk.
Bought Deals and Other Forms of Initial Public Offerings
There are several kinds of initial public offerings (IPOs). Two common methods, fixed price and book building IPOs, are similar to bought deals in that they can result in a fully subscribed IPO. A company can employ fixed price and book building IPOs separately or combined, and a bought deal can employ these methods for reselling the securities as well.
In a fixed price offering, the company going public (the issuing company) determines a set price at which it will offer its shares to investors. In this scenario, investors know the share price before the company goes public. Investors must pay the full share price when applying for participation in the offering.
In book building, an underwriter will attempt to determine a price at which to offer the issue. The underwriter will base this price point on demand from institutional investors. As an underwriter builds their book, they accept orders from fund managers. Fund managers will indicate the number of shares they desire and the price they are willing to pay.
The Role of the Underwriter in Bought Deals
In all forms of IPOs, including bought deals, the underwriters and/or a syndicate of underwriters will facilitate some or all of the following:
- The formation of an external IPO team, consisting of an underwriter(s), lawyers, certified public accountants (CPAs), and Securities and Exchange Commission (SEC) experts
- The compilation of detailed company information, including financial performance and expected future operations
- The submission of financial statements for official audit
In most forms of IPOs, except that of a bought deal, underwriters will support the compilation and filing of a preliminary prospectus with the SEC prior to setting the offering date. In a bought deal, the issue is purchased by the underwriter before the preliminary prospectus is filed. Again, this leaves the underwriters with capital tied up in a stock they need to unload—ideally for a profit.