In the world of investment banking, a Best Efforts Arrangement is a commitment where investment bankers, acting as agents, agree to make their best attempt to sell a client’s securities to the public. Unlike firm commitment underwriting, where bankers buy the securities outright and resell them, here they do not purchase the securities directly but have the option to purchase and the authority to sell them.
Mechanism of Best Efforts Arrangement
Investment Banker’s Role
Under a best efforts arrangement, investment bankers serve as intermediaries between the issuer and potential investors. They undertake the responsibility to sell the securities at the best possible terms but are not obligated to guarantee the sale of all the securities.
Process
- Issuance Agreement: The issuer and investment banker draft an agreement outlining the terms of the best efforts arrangement, including the volume and price range of the securities to be sold.
- Marketing: The bankers then engage in marketing the securities to potential investors through roadshows, meetings, and financial presentations.
- Sale: Based on investor interest, the bankers sell the securities, transmitting funds to the issuer proportionate to the number of securities successfully sold.
Key Considerations
Flexibility
- Issuer’s Perspective: Provides flexibility since the issuer is not selling securities at a fixed price and volume, mitigating risk in case of lower-than-expected demand.
- Banker’s Perspective: Minimizes risk as the bankers do not have to buy the unsold securities, protecting themselves from potential losses if the market responds unfavorably.
Pricing and Risk
Pricing under a best efforts arrangement is often more dynamic and closely aligned to current market conditions as opposed to a firm commitment that predefines the price. The risk primarily revolves around market volatility and investor demand fluctuations.
Examples and Applications
Historical Context
The best efforts arrangement gained popularity due to its lower risk profile for investment bankers and flexibility for issuers. Historically, smaller companies or those entering the market for the first time opt for best efforts arrangements as they navigate investor interest and market conditions.
Modern Use Cases
In current times, best efforts arrangements are common for initial public offerings (IPOs) by smaller firms or during tumultuous market periods. For instance, a technology startup might choose this route to mitigate risk while reaching out to potential investors.
Comparative Analysis
Best Efforts Arrangement vs. Firm Commitment
- Risk Assumption: In a firm commitment, investment bankers assume full risk by buying securities outright, whereas, in best efforts, the risk is retained by the issuer.
- Market Demand: Best efforts arrangements are preferable in volatile markets, while firm commitments are suitable in stable market conditions.
Related Terms
- Firm Commitment Underwriting: A method where investment bankers purchase the entire securities directly from the issuer, assuming full financial risk.
- All-or-None (AON) Offering: A stipulation that securities sales are only executed if all the offered securities are successfully sold to investors.
FAQs
What is the primary benefit of a best efforts arrangement for the issuer?
Do investment bankers guarantee the sale of securities in a best efforts arrangement?
When should an issuer consider a best efforts arrangement?
References
- Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions by Joshua Rosenbaum and Joshua Pearl
- Principles of Corporate Finance by Richard Brealey, Stewart Myers, and Franklin Allen
- The New Financial Order: Risk in the 21st Century by Robert J. Shiller
Conclusion
The best efforts arrangement is a strategic approach within investment banking, balancing risk between issuers and underwriters while ensuring market-based securities pricing. It remains a vital option for entities navigating their initial forays into public securities offerings or operating in volatile market environments.
