What Is Securities Underwriting?

The securities underwriting process requires at least two participants, including a client, such as a corporation or a government entity, and an investment bank. When an issuer, such as the company or government, needs to raise money, it turns to the capital markets to either sell equity or debt. In order to execute the sale, one or more investment banks are hired for the securities underwriting process. The investment bank is responsible for underwriting those securities, a process that includes pricing, buying, and reselling those shares back to the public.

When a company issues equity shares or stock to the public for the first time, it's known as an Initial Public Offering (IPO). Usually, several investment banking firms are hired to underwrite the securities, including a lead bank and several other banks with more junior roles. Between the investment banking teams and the company's management team, several financial details of the deal are decided, and this is all part of the securities underwriting process.

First, the size of the IPO must be determined, including the number of shares that will be issued in the stock market and the price of those shares. The date for the IPO must also be determined, and prior to the release, the bankers and management often go on a road show to market and promote the forthcoming sale of stock to the public. Prior to the issue date, the investment banks purchase the equity shares for a designated price, immediately generating profits for the company. Those shares are priced to the public at a greater amount so that the bankers on the deal earn profits as a result of the securities underwriting services.

Pricing is a delicate matter in the securities underwriting process. If shares are priced too high to the public, the bank will not be able to unload those shares and will be forced to try and sell them in the future. Pricing the stock too low could result in lost profits for the underwriters and the company issuing shares.

In exchange for providing securities underwriting services, investment bankers have the potential to earn generous fees. Those revenues are frequently based on the size of the transaction being accomplished in the financial markets. For instance, the banker might earn a percentage of the total value of an IPO. Also, the banker will very likely earn a bonus at year end based on the value of business brought to the investment banking firm.