Back Stop: Definition, How It Works in Offering, and Example
A backstop (also known as a backstop) in corporate finance and investment banking refers to giving last-resort assistance or bidding for the percentage of shares that remain unsold in a securities offering.
An underwriter or a significant stakeholder, such as an investment bank, may provide a backstop to purchase any of the company’s unsold shares when it attempts to raise money through issuance and wishes to guarantee the amount acquired through the issue.
The Operation of a Backstop
A backstop serves as a type of protection. Although not quite the same as an insurance plan, a corporation can ensure that, if not enough investors are attracted to the open market and some of the offerings are unsold, a particular portion will be bought by specific organizations, most often investment banking companies.
Sub-underwriters acting on behalf of the investment banking business will contract with the company if it is the entity offering the backstop. Known as a firm-commitment underwriting deal or contract, this arrangement commits to buying a certain quantity of unsold shares, providing overall support for the offering.
The connected organization has promised to supply the associated capital in return for the available shares, and by engaging in a firm-commitment underwriting agreement, it has taken complete responsibility for the number of shares stated if they are originally unsold.
This can reassure the issuer that the required capital can be raised, irrespective of open market activity. Furthermore, all risk about the designated shares is shifted to the company underwritten. Should the whole offering be acquired through conventional investment vehicles, the agreement requiring the organization to buy back any unsold shares becomes null and invalid since the terms of the purchase commitment are no longer relevant.
Several types of agreements might exist between an issuer and the underwriting company. For instance, the underwriting company may provide the issuer with a revolving credit loan to improve the issuer’s credit ratings. They could also issue letters of credit to provide assurances to the organization obtaining funds through offers.
Extra Attention to Detail
As stated in the agreement, if the underwriting organization gains ownership of any shares, they become the organization’s property to be managed however it sees suitable. The shares are handled like any other investment acquired via regular market activity. The issuing corporation may place no limitations on the trading of the shares.
The underwriting organization may hold or sell the related securities by the rules governing the overall activity.
A Back Stop Example
A rights offering may state Something like this: “Any portion of the XYZ Company rights offering that is not subscribed will have a 100% back stop from ABC Company up to a maximum of $100 million.” ABC Company will buy the remaining amount if XYZ tries to fund $200 million, but investors only contribute $100 million.
In a bond issue, what is a backstop?
A backstop for bond issuance, like a backstop in an equity placement, guarantees that the underwriting bank or syndicate will set a price to buy any unsold or unsubscribed bonds.
Who Makes Up the Backstop Buyers?
It may be necessary to turn to third-party backstop purchasers to purchase any unsold shares of a securities issuance if the underwriting bank or investment banking syndicate is unable or unwilling to backstop a fresh issue. These buyers may provide a bid that is less than the issue price and may want payment in the form of fees. They would then frequently attempt to sell off the shares for a profit.
The Volcker Rule Backstop Provisions: What Are They?
A set of financial laws, the Volcker Rule, keeps a company’s commercial and investment banking operations apart. Its goal is to stop situations where a bank’s clients suffer from unfair practices and conflicts of interest. An underwriting bank cannot backstop a securities offering if doing so would put them in a conflict of interest, according to one rule of the rule. In addition, a backstop is prohibited if it would “result, directly or indirectly, in a material exposure by the banking entity to a high-risk asset or a high-risk trading strategy; or pose a threat to the safety and soundness of the banking entity or to the financial stability of the United States.”
Conclusion
- Offering security or last-resort support in a securities offering for a fraction of shares to be subscribed for is known as a backstop.
- When a business attempts to raise money through an issue, it could get support to purchase any of its unsold shares from an underwriter or a significant shareholder, such as an investment bank.
- To ensure that the offering doesn’t collapse, if not all shares are subscribed, backstops serve as a sort of “insurance” and support for the entire offering.
