Underwriting a stock or bond deal can be very difficult and work-intensive: you need to coordinate your t-shirts for the pitch, manage logistics ranging from prospectus writing to investor-lunch-sandwich-buying, and actually convince investors to buy whatever it is you’re selling. But it can also be very easy. The limit case of easy underwriting is:
- Your phone rings at noon on a Tuesday.
- You answer it.
- “Hi, it’s Company X. How’d you like us to write you a check for $100,000 in exchange for letting us put your name on the cover of a document?”
- “Sounds good,” you say.1
- “Great, there’s a diligence call at 4:15pm. We price at 4:30.”
I’ve always liked the purity of this business model: basically, someone writes you a check, and you deposit it,2 and that’s that; you never sully yourself by actually providing them any service. But what’s in it for the client: why write you a check for doing nothing?
The answer goes something like this:
- There are fixed-ish fees for underwriting services – 7% for IPOs, 3% for follow-on equity, 2-3% for high-yield, a sliding scale based on maturity for IG.
- If you want actual underwriting done – someone to write a prospectus, call investors, and market the deal – you gotta pay those fees.
- Unless you’re Facebook or something, you have to pay pretty much the full fees.
- But you don’t have to pay all of them to the bank or banks actually doing the underwriting.
- Generally you have to pay each active bank at least as much as you pay any other bank,3 but you can still hand over a decent chunk of the fees to lower-level passive bookrunners, co-lead managers, co-managers, and other fancy titles for “bank that receives check.”
- So you essentially have “free” soft money: you’re writing a $3mm check anyway for that $100mm deal, but you can allocate $1mm or so of it to anyone with a securities license.
- So you might as well hand that free money to banks who’ve been nice to you: banks who lend you money at below-market rates, say, or advisors who’ve done lots of free work on M&A ideas that have never happened.