In the world of capital markets, a “bought deal” is a term that refers to a form of transaction in which a company or issuer sells a number of new shares directly to an underwriter or certain buyer. These transactions often involve financial institutions or underwriters who will buy the entire number of shares offered by issuers with the aim of selling them to other investors. Bought deal is a method of issuing shares that has certain characteristics and is usually used in certain situations.
Bought Deal Process
1. Offer from Issuer: The bought deal process begins when the issuer, which is a company that wants to issue new shares, submits an offer to an underwriter or financial institution that is willing to buy the shares. This offer includes the number of shares to be issued, the offering price, as well as other terms related to the transaction.
2. Underwriter Approval: After receiving an offer from the issuer, the underwriter will conduct an analysis and consideration of the offer. If the underwriter agrees with the terms and prices proposed by the issuer, then the underwriter will agree to buy the entire number of shares offered.
3. Purchase of Shares by the Underwriter: After the approval is given, the underwriter will buy all the shares proposed by the issuer. The underwriter will pay the issuer the price agreed upon in the offer.
4. Sales to Investors: After the underwriter owns the shares of the issuer, the next step is to sell the shares to investors in the market. The underwriter will sell shares at a higher price than the purchase price from the issuer, so that the underwriter benefits from the difference in price (spread).
Bought Deal Advantages and Challenges
Advantages :
– Certainty of Issuance: The bought deal method provides certainty that all shares offered by the issuer will be purchased by the underwriter. This avoids the risk of failed share issuance that may occur in other share issuance methods.
– Time Efficiency: The buying deal process is usually quicker than other methods of issuing shares, as there is no public offering stage to potential investors. This can save time for issuers who want to get funds immediately.
– Ease of Selling: Underwriters have a wider network and access to investors, so selling shares to investors is easier and faster.
Challenge:
– Fair Price: While a buy deal ensures the issuer gets funds in a short time, the price agreed with the underwriter must be fair and take into account the actual value of the stock.
– Underwriter’s Risk: Underwriters take the risk of buying all the shares of the issuer, as they have to sell those shares at a higher price to make a profit. If the share price falls after purchase, the underwriter may face losses.
Example of Issuing Shares using the Bought Deal Method
Consider a technology company called XYZ Tech that is experiencing rapid growth. This company wants to obtain additional funds to support business expansion and new product development. For this reason, XYZ Tech decided to issue new shares in order to increase capital.
The steps for issuing shares using the bought deal method are as follows:
1. Offer by Issuer (XYZ Tech): XYZ Tech submitted an offer to a large financial institution to act as underwriter. XYZ Tech proposes to issue 1 million new shares at an offering price of $50 per share.
2. Underwriter Approval (Financial Institution): After receiving an offer from XYZ Tech, the financial institution acting as underwriter carries out an analysis of the market situation, XYZ Tech’s financial performance, and the company’s future prospects. If the underwriters feel confident about XYZ Tech’s prospects, they agree to purchase all 1 million shares offered at $50 per share.
3. Purchase of Shares by Underwriter: After approval was given, the financial institution as underwriter purchased all 1 million new shares from XYZ Tech with a total value of $50 million ($50 per share).
4. Sales to Investors: Underwriters start selling the shares they have purchased from XYZ Tech to investors on the open market. They sell the shares at a higher price than the purchase price, for example $55 per share. This allows the underwriter to profit from the price difference ($5 per share).
Result:
In this example, XYZ Tech managed to raise $50 million from issuing shares using the bought deal method. The underwriter, after purchasing shares for a total of $50 million, sells them to investors at a higher price, such as $55 per share, so that they make a profit equal to the price difference.
However, if the price of XYZ Tech shares in the market falls after the bought deal is made, the underwriter may face the risk of loss. For example, if the stock price falls to $45 per share after the underwriter buys shares of XYZ Tech, the underwriter might sell at the lower price and suffer a loss.
Bought deals offer a unique and efficient way for companies to raise capital and for investors to access exclusive investment opportunities. This provides speed, certainty, and the potential for short-term profits. However, companies must carefully weigh the potential downsides, such as price discounts and dilution of ownership, while investors must assess the risk of market volatility and limited information. By understanding the mechanics and nuances of a bought deal, both companies and investors can make the right decisions and unlock the potential benefits offered by this investment strategy.
Conclusion
In the example of issuing shares using the bought deal method, XYZ Tech succeeded in raising the required funds by selling new shares to the underwriter. The underwriter then sells the shares to investors on the open market at a higher price to make a profit. Even though a bought deal provides certainty in raising funds, there is a risk of share prices in the market which can affect the underwriter’s profits or losses.
Bought deal is a method of issuing shares in the capital market where the underwriter buys the entire number of shares offered by the issuer and then sells them to investors. This method provides certainty and time efficiency for issuers, while the underwriter has an important role in buying and selling shares. While it has its advantages, bought deals also come with challenges in setting a fair price and managing underwriter risk. This method is one of the options available to companies wishing to issue new shares to raise the necessary funds.
