A bought deal is a type of securities offering in which the underwriter commits to buying the entire offering from the issuer company before a preliminary prospectus is filed. A bought deal eliminates the financing risk faced by the issuer company.
How It Works
In a bought deal, the underwriter purchases the entire offering from the issuer company. As the entire offering is purchased, financing risk is eliminated for the issuer company. To compensate for eliminating the financing risk faced by the issuer company, the underwriter would negotiate a discounted price for the entire offering.
In such a scenario, the underwriter faces the risk of losing money by not being able to resell the securities at a higher price. In a bought deal, the underwriter acts as the principal rather than the agent. An illustration of a bought deal is provided below:
Example of a Bought Deal
An issuer company is looking to offer 40 million shares. The projected market value per share is $10, but there is no guarantee that all shares of the issuer company would be purchased. In order to avoid financing risk (the risk of not being able to sell all of its shares at the market price), the issuer company engages in a bought deal with its underwriters. The underwriters and the issuer company come to a heavily discounted consensus price of $6 per share, and the underwriters purchase the entire offering at $240 million (40 million shares at $6 per share).
As the underwriters now own the entire offering, they must resell the issuer’s shares at a price of at least $6 per share or face the risk of generating a net loss. The issuer company is alleviated of financing risk but receives financing at a discounted price per share ($6) as opposed to the market value per share ($10).
Advantages of a Bought Deal
A bought deal offers several advantages to both the underwriter and the issuer company.
Advantages to Underwriters
The underwriters are able to purchase the offering at a steep discount to market value; and
The higher the price that the underwriters are able to resell on the market, the greater the profits realized by the underwriters.
Advantages to Issuer Company
The issuer company faces no financing risk; and
The issuer company receives funds instantly.
Disadvantages of a Bought Deal
A bought deal comes with a few disadvantages for the underwriter and the issuer company.
Disadvantages to Underwriters
The underwriters see their capital tied up, which potentially could’ve otherwise been put to better use; and
The underwriters face the risk of not being able to resell the issue;
Disadvantages to Issuer Company
The issuer company generally must agree to a large per-share discount.
Bought Deal in a Press Release
Bought deals are common to see in the news. For example, the following is an excerpt of a press release involving The Flowr Corporation (TSX.V: FLWR). From the discussion above, readers should be able to interpret that the underwriters are purchasing 10,610,000 units of The Flowr Corporation at a price of $4.10 per unit (valued at $43,501,000).
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