What it means
When a company raises large amounts of money, no single bank wants to carry all the risk that the securities will not sell. Instead the lead underwriter, also called the bookrunner or managing underwriter, invites other banks to join a syndicate.
Each member agrees to take a stated share of the issue. The syndicate sells the securities to investors at the offer price and keeps the difference between that price and what it paid the issuer.
That difference is called the gross spread (or underwriting discount), and it is shared among the banks according to the roles they played. Spread is usually split into three parts: a management fee for the lead banks that organise the deal, an underwriting fee for the risk taken, and a selling concession for the firms that actually place the securities with investors.
The exact proportions vary by deal and are fixed in the syndicate agreement. A wider group may also include a selling group, which is a set of dealers that help distribute the securities but do not take underwriting risk.
The syndicate agreement spells out who is liable if the issue does not sell, how stabilisation purchases will be handled and how long the arrangement lasts. For issuers, a strong syndicate gives access to many different investors and can improve pricing.
For banks, joining one earns fees and builds relationships, although a weak market can turn a syndicate position into a loss. Syndicates are not used only for share issues.
Large loans, such as those for acquisitions or infrastructure, are often arranged by a syndicate of lenders so that no single bank holds the entire exposure. The mechanics differ, but the principle of sharing risk and workload is the same.
In practice
Real-world examples.
Example
A healthcare company is preparing a $500,000,000 flotation. Three global banks form the core of a syndicate and invite eight regional banks to take smaller shares so the shares reach investors in several countries.
Example
A utility sells $300,000,000 of bonds through a syndicate led by one bank. When demand is strong the syndicate sells the whole issue in a day, and each member earns fees in proportion to its commitment.
Example
A mid-sized retailer wants to raise $40,000,000 in new equity. A smaller syndicate of just two banks is enough, because the amount is modest and each bank can comfortably carry half the risk. Splitting the issue this way keeps each bank's position manageable if some shares remain unsold.
Formula
Calculation
Gross spread = Offer price x Shares x Spread percentage
A company issues 4,000,000 shares at $25, a deal worth 4,000,000 x $25 = $100,000,000. The gross spread is 6%.
Gross spread = $100,000,000 x 6% = $6,000,000
Net proceeds to the issuer = $100,000,000 - $6,000,000 = $94,000,000
Suppose the syndicate splits the spread 20% management fee, 20% underwriting fee and 60% selling concession (illustrative proportions).
Management fee = $6,000,000 x 20% = $1,200,000
Underwriting fee = $6,000,000 x 20% = $1,200,000
Selling concession = $6,000,000 x 60% = $3,600,000
The three parts add up to $1,200,000 + $1,200,000 + $3,600,000 = $6,000,000.
Each bank's exposure follows its share. If the lead bank takes 40% of the commitment, it must buy 40% x 4,000,000 = 1,600,000 shares, worth 1,600,000 x $25 = $40,000,000 at the offer price.Case study
Seen in the real world.
Brightwave Energy is an illustrative, fictional renewable-power developer that plans a $240,000,000 share offering. Its chosen lead bank would not take the whole risk alone, so it formed a syndicate of five banks, taking 40% itself and 15% each for the other four fictional firms.
During the roadshow, a market sell-off made investors cautious and the shares priced at the bottom of the range. Because the syndicate had committed to buy the shares, Brightwave still received its money on the closing date, while the banks held some unsold shares for a few days.
The illustrative story shows what the syndicate is for: the issuer buys certainty, and the banks accept a temporary risk in return for a fee. Brightwave's finance director later said the fee was worth paying for certainty, since a failed offering would have delayed the construction of two wind farms.
Watch out
Common mistakes.
- Thinking the lead bank carries all the risk, when each syndicate member is committed for its own share or, in some structures, for a share of unsold securities.
- Confusing the underwriting syndicate with the selling group, which sells securities but takes no underwriting risk.
- Assuming the gross spread is pure profit for the banks, when it also covers legal costs, marketing and the cost of carrying risk.
Questions
People also ask.
Why do banks form a syndicate rather than act alone?
Sharing the issue spreads risk and extends distribution to more investors than any one bank can reach.
Who leads an underwriter syndicate?
The lead manager, or bookrunner, which runs the roadshow, builds the order book and sets the price with the issuer.
How do syndicate members get paid?
They share the gross spread, split between a management fee, an underwriting fee and a selling concession.
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