What distinguishes firm commitment underwriting from best efforts underwriting?

The distinction between firm commitment underwriting and best efforts underwriting primarily revolves around the obligations of the underwriter concerning the sale of shares.

In a firm commitment underwriting arrangement, the underwriter agrees to purchase all the shares being offered in the initial public offering (IPO) from the issuer, thereby ensuring that all shares are sold at the agreed price. This guarantees that the issuing company receives the full amount of capital it aims to raise, regardless of whether the shares are ultimately sold to the public. The risk of not being able to sell the shares is borne entirely by the underwriter once the agreement is made.

In contrast, the best efforts underwriting approach does not come with the same guarantee. The underwriter commits to sell as many shares as possible but does not guarantee the sale of all shares. This means that the issuing company may not receive the intended capital if the underwriter cannot sell every share. This structure is more flexible for the underwriter but carries more uncertainty for the issuing company regarding the funds it will ultimately receive.

By focusing on the guarantee aspect of firm commitment underwriting, we can see why this choice elucidates a fundamental difference between the two underwriting methods. Best efforts do not provide such certainty, making the explanation clear and reinforcing the key characteristics of each approach