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What is a Bought Deal?
What’s important to know about it?
In this article, I will break down the meaning of Bought Deal so you know all there is to know about it!
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What Is A Bought Deal
In finance, a bought deal refers to the scenario where an underwriting firm acquires an issuer’s offering before the issuer’s preliminary prospectus is filed.
In other words, for the company issuing securities, the offering is “bought” by the underwriting.
This means that the underwriting takes a long position in the issuer’s securities and will no longer act as an agent for the issuer but will be the principal selling the securities to the market.
Bought deals are attractive for issuers as they no longer have to worry about any financing risk as they have the underwriter’s commitment to buy the securities offering.
For underwriting, a bought deal can be interesting as it can purchase the securities at a discount and sell it to the market for a profit.
In essence, the financing risk is transferred from the issuer to the underwriter who may or may not be able to sell the entire offering above its purchase price.
Keep reading as I will further break down the meaning of a bought deal and tell you how it works.
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How Does A Bought Deal Work
Let’s look at an example of a bought deal to see how it works.
Let’s say that Company XYZ is looking to raise capital by selling 10 million shares.
The market value per share is estimated to be $20 per share.
Company XYZ agrees with its investment banking firm that they will purchase the entire 10 million share offering for $13 per share.
In this case, the underwriter will pay $13 million to Company XYZ and will hope to sell the shares in the market at the projected $20 per share allowing it to earn a $7 million profit.
In this scenario, Company XYZ is happy as they know that they will definitely receive $13 million (although it’s below the projected $20 million) and will not face any financing risk.
The underwriter can win if it is able to sell the securities above $13 per share as it will result in a net profit to the firm.
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Bought Deal Advantages
There are several advantages for issuers and underwriters to agree on the terms of a bought deal.
As for the issuer, the most important advantage is that it will no longer be exposed to any financing risk.
In other words, the issuer will not have to worry if it will be able to sell its securities to the market and at what price.
Another advantage for the issuer is that it will be able to get the proceeds of the sale quickly as it’s the underwriting that is purchasing the securities.
For the underwriter, the main advantage is that it can negotiate an important discount on the offering so it can eventually sell the securities for a greater profit margin.
Also, if the value of the underlying securities goes up, the underwriter’s profit will become much larger.
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Bought Deal Disadvantages
Although there are several advantages in selling securities in a bought deal transaction, there are also certain disadvantages to be aware of.
For the issuer, the first important disadvantage is that it will not be able to get into a bought deal transaction if it does not offer the underwriter a significant discount on the market value of the securities.
Also, although the issuer is reducing its financing risk by agreeing to a bought deal, it will potentially lose out on the total amount of financing that it could have obtained without selling its securities at a discount.
From the underwriter’s perspective, a bought deal presents an important disadvantage as it must use its own capital to purchase the securities from the issuer.
Also, if the underwriter cannot sell the securities quickly, its capital may get tied up for extended periods.
Another risk to the underwriter is that it may not be able to sell the securities at all and will be stuck with an unwanted long position in the issuer securities.
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Bought Deal Meaning FAQ
What does a bought deal mean in finance?
A bought deal occurs when an underwriting firm purchases securities from an issuer before a preliminary prospectus is filed.
In a bought deal, the underwriter will sell the securities as a principal and will no longer act as the agent of the company.
Why do companies sell securities in a bought deal?
Companies that are looking to raise capital may consider entering into a bought deal arrangement with an underwriter to eliminate their financing risk.
If a company really needs the capital to fund its business, it may find that selling securities to the underwriter at a steep discount may be worth it as it can quickly access the required capital.
What are different forms of offerings aside from bought deals?
Aside from bought deals, there are different types of securities offerings allowing a company to raise capital.
One type of offering is the fixed price offering where a company sets a specific price to sell its shares to investors in an initial public offering.
Another type of offering is book building where the underwriter will attempt to determine a price for the offering of the shares based on market demand.
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So there you have it folks!
What does a bought deal mean?
In a nutshell, a bought deal is when an investment banking firm or underwriting agrees to buy an entire securities offering from a company before a prospectus is filed.
The company wins as it is able to eliminate financing risk and ensure that it will raise the required amount of capital to fund its business operations.
The underwriter can win as it will generally purchase the securities at a significant discount and will sell it to the market for a larger profit.
In the context of a bought deal, the investment banking firm is essentially taking a bet by taking a long position in the securities offering and hoping to sell the same to the market for a large profit.
Now that you know what a bought deal is all about and how it works, good luck with your research!
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