Underwriting Spread

What Is an Underwriting Spread?

An underwriting spread is the difference between the price investors pay for newly issued securities and the amount of money the issuer actually receives from the sale. It is the main fee that investment banks earn for helping a company or government sell stock or bonds to the public. When a company goes public through an initial public offering (IPO) or later sells more shares through a follow-on offering, the underwriters typically buy the securities from the issuer at a discount and resell them at the offering price. The gap between those two prices is the spread. Because the underwriter often takes on the risk that the securities will not sell as expected, the spread pays for that risk as well as for distribution.

How It Works

The spread is usually made up of three parts:

• A management fee, paid to the lead firm that organizes the deal.
• An underwriting fee, which compensates the firms that share the risk of the offering.
• A selling concession, paid to the brokers who sell shares to their clients.

The spread is expressed as a percentage of the offering price. In a hypothetical example, if shares are sold to investors at $20 each and the issuer receives $19 per share, the underwriting spread is $1 per share, or 5 percent of the offering price.

Why It Matters to Investors

Investors do not pay the spread as a separate charge. Instead, it reduces the proceeds the issuer receives, so the company raises less money than the headline size of the offering. This is one reason the gross amount of an offering can differ substantially from the net amount the company keeps.

Spreads vary by deal type. Smaller offerings usually carry a higher percentage spread because they require more marketing effort, while large bond issues from frequent borrowers typically have much smaller spreads. Offering documents such as a prospectus disclose underwriting compensation, which allows readers to see how much of the money raised goes to intermediaries.