What it means
Underwriting fees compensate a bank for two quite different services. One is the work of structuring the offering, preparing documentation and finding buyers; the other is the risk of committing to buy securities that may prove hard to sell.
The fee matters because it comes straight out of the money raised. A business that announces it has raised $200,000,000 will bank meaningfully less, and the difference is large enough to change how many months of runway a fundraising actually buys.
The percentage is known as the gross spread and it varies with deal type and risk. Small initial public offerings often sit near 7%, larger flotations settle nearer 3% to 5%, follow-on share offerings are cheaper again, and investment grade bond issues are usually well under 1%.
The spread is normally divided three ways inside the syndicate: a management fee for structuring the deal, an underwriting fee for carrying the risk, and a selling concession paid to whoever actually places the securities. The selling concession is usually the largest slice, which is why distribution power rather than balance sheet strength tends to decide who leads a deal.
Underwriting fees are only part of the cost of coming to market. Legal advice, accountants' reports, listing fees, printing and investor relations can add several million dollars more, and accounting rules generally require these issuance costs to be charged against the equity raised rather than run through the profit and loss account.
In practice
Real-world examples.
Example
A biotechnology company raises $60,000,000 in a small initial public offering at a 7% gross spread, so the banks take $60,000,000 x 0.07 = $4,200,000 and the company receives $55,800,000. The founders are surprised at how much of the round never reaches the bank account.
Example
A large industrial group issues $500,000,000 of investment grade bonds at a spread of 0.45%, producing fees of $2,250,000. The low percentage reflects how easy the paper is to place with insurers and pension funds.
Example
An already listed retailer raises $150,000,000 in a follow-on share offering at a 3% spread, paying $4,500,000. The fee is roughly half the rate it paid at flotation because the shares now have a trading history and a known investor base.
Formula
Calculation
Underwriting fees = gross proceeds x gross spread percentage
Net proceeds = gross proceeds - underwriting fees
A medical devices business sells 8,000,000 shares at $25.00 each, so gross proceeds are 8,000,000 x $25.00 = $200,000,000. The syndicate charges a gross spread of 6.5%, giving underwriting fees of $200,000,000 x 0.065 = $13,000,000 and net proceeds of $200,000,000 - $13,000,000 = $187,000,000.
Expressed per share, the fee is $13,000,000 / 8,000,000 = $1.625, so the company effectively receives $25.00 - $1.625 = $23.375 for each share sold, and 8,000,000 x $23.375 = $187,000,000 as before.
Splitting the $13,000,000 in the usual 20 / 20 / 60 proportions gives a management fee of $2,600,000, an underwriting fee of $2,600,000 and a selling concession of $7,800,000, which add back to $2,600,000 + $2,600,000 + $7,800,000 = $13,000,000.Case study
Seen in the real world.
Larkfield Diagnostics is an illustrative, fictional maker of laboratory testing equipment that planned an $80,000,000 flotation. The lead bank opened the discussion at a 7% gross spread, which would have cost $80,000,000 x 0.07 = $5,600,000.
The finance director ran a competitive process across four banks and settled at 6.25%, or $80,000,000 x 0.0625 = $5,000,000, saving $600,000. Legal, audit, listing and printing costs added a further $2,400,000, taking total issuance costs to $5,000,000 + $2,400,000 = $7,400,000, or 9.25% of the gross amount raised.
The company therefore banked $80,000,000 - $7,400,000 = $72,600,000. In this fictional example the board had budgeted its post-listing spending against the $80,000,000 headline and had to rework the first year's plan once the real figure landed.
Watch out
Common mistakes.
- Budgeting against the gross amount raised rather than the net proceeds, which overstates available cash by several million dollars on a mid-sized deal.
- Assuming the underwriting fee is the only cost of listing, when legal, audit and listing charges often add half as much again.
- Treating the quoted spread as fixed, when it is negotiable and moves with deal size, sector risk and how competitive the pitch process is.
Questions
People also ask.
Are underwriting fees an expense in the profit and loss account?
Generally no for an equity raise, where they are charged against the equity raised, though fees on debt issues are usually spread over the life of the borrowing.
Why are bond underwriting fees so much lower than equity fees?
Because investment grade bonds are easier to price and place, carry less inventory risk for the bank and are sold to a smaller, more predictable group of buyers.
Can a company negotiate the spread?
Yes, and larger or better known issuers routinely do, though very small deals have little room because the banks' fixed costs of running a transaction do not shrink with deal size.
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