Bought deal financing is a type of financing arrangement commonly used in the world of investments and capital markets. It involves the sale of securities, such as stocks or bonds, by a company directly to an underwriter or a group of underwriters, who then resell them to investors. This form of financing is often sought after by companies looking to raise capital quickly and efficiently.
How Does Bought Deal Financing Work?
The process of bought deal financing typically starts with a company seeking to raise funds for various purposes, such as expansion, acquisitions, or debt repayment. They approach an underwriter, usually an investment bank, who agrees to purchase a predetermined number of securities from the company at a fixed price.
Once the terms are agreed upon, the underwriter takes on the risk associated with the securities and commits to selling them to investors. The underwriter then conducts a marketing campaign to generate interest and attract potential buyers for the securities. This could involve roadshows, presentations, or targeted advertisements to reach the right investor base.
When the marketing efforts are successful, the underwriter allocates the securities to investors at a price higher than the fixed price paid to the company. The difference between the price paid to the company and the price received from the investors represents the underwriter’s profit.
Advantages of Bought Deal Financing
Bought deal financing offers several advantages for both companies and underwriters:
1. Speed and Efficiency: With bought deal financing, companies can raise capital quickly, often within a matter of days, compared to other forms of financing that may take weeks or months to complete. This allows companies to seize market opportunities or address urgent financial needs promptly.
2. Certainty of Funding: Once the underwriter commits to the bought deal, the company can be assured of receiving the agreed-upon funds. This certainty is particularly beneficial when companies need to meet specific financial obligations or deadlines.
3. Reduced Market Risk: By selling the securities to the underwriter, the company transfers the market risk associated with selling the securities to the underwriter. The underwriter, in turn, takes on the responsibility of finding buyers for the securities.
4. Access to Underwriters’ Expertise: Underwriters are experienced professionals in the field of investments and capital markets. Companies benefit from their expertise and guidance throughout the financing process, including pricing, marketing, and regulatory compliance.
Disadvantages of Bought Deal Financing
While bought deal financing offers several advantages, there are also some potential drawbacks to consider:
1. Pricing Risk: The fixed price agreed upon between the company and the underwriter may not fully reflect the market value of the securities. If the market value is significantly higher than the fixed price, the company may miss out on potential profits.
2. Market Conditions: The success of bought deal financing heavily relies on favorable market conditions. If market conditions deteriorate or investor sentiment changes, the underwriter may struggle to find buyers for the securities, leading to potential delays or renegotiations.
3. Share Dilution: When a company issues additional securities, it may result in share dilution for existing shareholders. This can impact the ownership percentage and earnings-per-share of existing shareholders.
Conclusion
Bought deal financing provides companies with a quick and efficient way to raise capital by selling securities directly to underwriters. This financing method offers advantages such as speed, certainty of funding, and access to underwriters’ expertise. However, it also comes with potential risks, including pricing risk, reliance on market conditions, and share dilution. Understanding the intricacies of bought deal financing can help companies make informed decisions when considering their financing options.