Firm Commitment

A firm commitment in the context of securities underwriting refers to an agreement where an underwriter pledges to purchase all securities offered by an issuer at a fixed price, with the intention of reselling them to the public to realize a profit. This type of arrangement provides the issuer with a guaranteed capital raise, as the underwriter assumes the risk of unsold inventory. Here's how it works: 1. **Underwriter's Role**: The underwriter, typically an investment bank, agrees to buy the entire issue of securities from the issuer at a negotiated discount. This purchase is usually done upfront, allowing the issuer to receive funds immediately. 2. **Profit Mechanism**: The underwriter then sells the securities to the public at a higher price, aiming to make a profit from the markup. If the securities are not sold to the public, the underwriter retains them, absorbing the risk of unsold inventory. 3. **Issuer's Benefits**: For the issuer, a firm commitment underwriting is desirable as it guarantees capital infusion and provides price stability in the short term. It also allows the issuer to plan future growth and expansion with certainty. 4. **Underwriter's Risks**: The underwriter faces the risk that they may not be able to resell all securities to the public, which could result in holding the securities at their own expense. This risk is mitigated by the markup in the selling price, which allows the underwriter to profit even if some securities are not sold. 5. **Comparison with Best Efforts**: Firm commitment underwriting is distinguished from best efforts underwriting, where the underwriter only tries to sell the securities to the public and does not guarantee a purchase of all securities. In summary, a firm commitment underwriting is a contractual arrangement that provides a guaranteed capital raise for the issuer while allowing the underwriter to profit from the securities' sale. It is a common practice in securities underwriting, particularly for higher-quality companies or those with indications of strong investor interest.