What is a bought deal?
It's when an investment bank commits to buy the entire securities offering of a client company – for example, all the shares in their initial public offering and take on the risk of selling them on to other investors. It's also known as a firm commitment.
Where have you heard about bought deals?
Although not that common in most capital markets, in Canada bought deals are standard practice, especially in its important energy markets. In fact, it is sometimes referred to as the Canadian advantage as companies are able to raise capital quickly without waiting for their shares to sell.
What you need to know about bought deals.
A bought deal reduces the financial risk for client companies because they are assured of raising the funds they need, and quickly. Instead, the investment bank shoulders all of the risk that the securities might not sell or might lose value before they are sold. For this reason, they often get a significant discount on the total price of the offering.
The difference between the price the investment bank pay for the shares and the price they sell them for ends up as their profit or alternatively their loss. The client company meanwhile could potentially end up making a loss on their shares if the IPO opening price ends up being higher.
For a large offering several investment banks may team together in a syndicate to mitigate the risk.
Find out more about bought deals.
In contrast to bought deals, in best effort deals the underwriter promises to make their best attempt to sell the shares but are not bound to buy the entire offering.