Firm Commitment
What is Firm Commitment?
A Firm Commitment is a type of underwriting agreement in which an underwriter (usually an investment bank) guarantees the sale of a certain number of securities from an issuing company by purchasing the entire offering upfront and then reselling them to the public.
In simple terms, the underwriter takes on the full risk of selling the securities—if they can’t sell them all to investors, they still have to pay the company for the entire issue.
How It Works?
- A company wants to raise capital by issuing shares or bonds.
- It hires an underwriter to manage the offering.
- In a firm commitment deal, the underwriter agrees to buy 100% of the securities at a fixed price.
- The underwriter then resells the securities to investors, hoping to make a profit from the markup.
Key Features
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Risk Transfer: The issuer transfers the risk of unsold securities to the underwriter.
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Guaranteed Funds: The issuer is guaranteed a certain amount of capital, regardless of investor demand.
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Price Stability: The underwriter usually works to maintain the offering price in the secondary market, at least in the short term.
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Higher Fees: Because the underwriter assumes more risk, firm commitment deals often involve higher underwriting fees.
Example
Suppose a company wants to issue ₹100 crore worth of shares. An investment bank agrees to underwrite the issue under a firm commitment. The bank pays ₹100 crore to the company upfront and then tries to sell the shares to investors at a slightly higher price. If the market response is poor and the bank sells only ₹80 crore worth, it still bears the loss on the remaining ₹20 crore.