What is Negotiated Underwriting?

Negotiated underwriting is a process whereby the issuer of new security and a single underwriter settle both the purchase price and the offering price. 

Key Takeaways

  • Negotiated underwriting refers to the agreement between an issuer and a single underwriter for the offering and purchase price of a new bond issue.
  • The difference between the purchase price and the public offering price is known as the underwriting spread and represents the profits which will go to the underwriting institution.
  • The underwriter may be required to assume ownership of shares which do not sell through a process called devolvement.

Understanding Negotiated Underwriting

In negotiated underwriting, a security issuer works with an underwriting bank to facilitate bringing the new issue to the market. The underwriting firm is selected well in advance of the intended date when the security will be offered for sale. Before the trade, the issuer and the underwriter will enter negotiations to determine a purchase price and offering price. Negotiated underwriting is essential during an initial public offering (IPO).

The purchase price is the price that the underwriter will pay for the new issue. This price must cover the cost of selling the bonds to investors, providing advice to the issuer about the offering, and additional costs to market the offering to institutional investors. The size and structure of the particular issue are also up for negotiation during a negotiated underwriting process. 

As the parties work through the process of negotiation, they will agree upon an offering price, which is the price that the public will pay. The difference between the purchase price and the public offering price is known as the underwriting spread and represents the profits which will go to the underwriting institution. In a negotiated process, the underwriter typically plays a role in marketing the security to potential investors.

If the issuer of a security does not have sufficient knowledge of debt financing to enter negotiations, an independent financial advisor can take on the role of a third-party negotiator on their behalf. Depending on the contract entered into, the underwriting bank may be required to assume ownership of shares which do not sell through a process called devolvement.

Negotiated vs Competitive Bid vs Private Placement

The purchase price paid to the issuer of new securities or debt through negotiated underwriting is one of two primary methods to market the new investment product. Choosing a system of sale is essential to the issuer of the security because it will impact the financing costs.

In a negotiated underwriting process, a single underwriter has the opportunity to make an exclusive bid. Municipal revenue bonds, corporate bonds, and common stock offerings most often use negotiated underwriting. 

However, in some cases, the state or local law may require competitive bid underwriting for municipal general obligation bonds and new issues of public utility bonds. In competitive bidding, some underwriters will make offers to the issuing company, who can choose the most favorable offer.

Securities may also be sold through private placement, in which the issuer sells bonds directly to investors without a public offering. This method is much more uncommon than either negotiated or competitive bid underwriting.