Backstop Purchaser
This is not a baseball team that signs up all the catchers they can find. Rather, a back-stop purchaser buys the leftover shares from the underwriter of an equity or rights offering. In that way, a back-stop purchaser is like an insurance policy. The purchaser guarantees that a company (and/or its investment bank) will raise the cash it needs to raise.
Example: Company A is going public. It plans to issue 10 million shares in an initial public offering (IPO). Bank B agrees to underwrite the IPO. Bank B does its research, or due diligence. Feeling good about the deal, Bank B agrees to sell the 10 million shares for $25 per share.
Bank B also comes to a special agreement with a wealthy hedge fund guy, Mr Hedge. Mr Hedge agrees to be Bank B's back-stop purchaser. If Bank ABC can't sell all the shares in the IPO, Mr. Hedge agrees to buy those leftovers. Being no dummy, Mr. Hedge obtains a fee for agreeing to be the back stop. He is taking on the risk of having to purchase and then trying to reissue Company A's securities.
Related or Semi-related Video
Finance: What is a greenshoe option?15 Views
finance a la shmoop what is a greenshoe option. oh you should be so lucky
green shoes on leprechauns and investment bankers are such a good thing. [leprechaun smiles]
why? well because when there is so much excess money laying all over the floor
your shoes turn green from the bills as you take whatever money you can carry
and run. that's how the name happened anyway a greenshoe option is a deal term
that an investment bank negotiates for in an IPO they run. and that IPO remember
is an initial public offering of stock. this can apply also to secondary
offerings and other kinds of offerings but we're focused on an IPO here as a
green shoe lives. if that IPO is marketed so well and there is so much demand for
shares in the company from the public that the bank believes it can raise the
IPO price and sell more shares to the public then that IPO was a huge winner.
the bank will exercise its greenshoe option and instead of selling 30 million [money falls from the sky]
shares of Chucky LARM calm to the public at 12 bucks a share well it'll bring the
company public at 15 bucks a share and sell 40 million shares. the math? it
raises 600 million bucks in the latter green shoe field option versus 360
million bucks in the former. the green shoe is the extra 10 million shares that
the bank can sell and get commission on while doing so. and if you think about
that world as a 5% kind of Commission world well the banks go from 18 million
in total Commission's to 30 million. yeah nice freakin bump especially when
there's a basic fixed cost of maybe 10 million dollars in either case. so you
make a lot more profit on the 30 million story here yeah? all right and having
more shares out there trading is a good thing for the company because its shares
are then more liquid. it's easier to buy and sell larger blocks of stock and the [stocks being sold in a graphic]
big institutions like that. they tend to then take a lot more
interest in the stock and usually that leads to higher stock prices down the
line. and all that liquidity or movement shares trading back and forth well
that's more Commission dollars in the future for the bank. so check your shoes
if they're green well you're either in the money or you should really get Rover
to the vet. [green poo on a wood floor]
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