What It Is:
In the securities industry an underwriter is a company, usually an investment bank, that helps companies introduce their new securities to the market.
 
In the insurance business, an underwriter is a company liable for insured losses in return for a fee (premium).
 
How It Works/Example:
When a company wants to issue stock, bonds, or other publicly traded securities, it hires an underwriter to manage what is often a long and complex process.
 
To begin the offering process, the underwriter and the issuer first determine the kind of offering the issuer needs. Sometimes the issuer wants to sell shares via an initial public offering (IPO) where the cash proceeds return to the issuing company as capital to fund its projects.  Other offerings such as secondary offerings funnel the proceeds to a shareholder who is selling some or all of his or her shares. Split offerings occur when a portion of the offering go to the company while the rest of the proceeds goes to an existing shareholder. Shelf offerings allow the issuer to sell shares over a two-year period.
 
After determining the offering structure, the underwriter usually assembles what is called a syndicate to get help manage the minutiae (and risk) of large offerings. A syndicate is a group of investment banks and brokerage firms that commit to sell a certain percentage of the offering. (This is called a guaranteed offering because the underwriters agree to pay the issuer for 100% of the shares, even if all the shares can’t be sold). With riskier issues, underwriters often act on a “best efforts” basis, in which case they sell as many shares as they can and return the unsold shares back to the issuing firm.
 
After the syndicate is assembled, the issuer files a prospectus. The Securities Act of 1933 requires the prospectus to fully disclose all material information about the issuer, including a description of the issuer’s business, the name and addresses of key company officers, the salaries and business histories of each officer, the ownership positions of each officer, the company’s capitalization, an explanation of how it will use the proceeds from the offering, and descriptions of any legal proceedings the company is involved in.
 
With prospectus in hand, the underwriter then proceeds to market the securities. This usually involves a road show, which is a series of presentations made by the underwriter and the issuer’s key executives to institutions (pension plans, mutual fund managers, etc.) across the country. The presentation gives potential buyers the chance to ask questions from the management team. If the buyers like the offering, they make a non-binding commitment to purchase, called a subscription. Because there may not be a firm offering price at the time, purchasers usually subscribe for a certain number of shares. This process lets the underwriter gauge the demand for the offering (called “indications of interest”) and determine whether the contemplated price is fair.
 

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