4. Choosing Your Investment Banker 29

The impact of retail versus institutional investors
An underwriter with a balanced mix of retail and institutional clients can provide shareholder diversity to your company. Institutional investors are usually viewed aslonger-term investors, but if they decide to sell, they can cause a considerable swing in the price of your stock. As a result, institutions often wish to have sufficient public float (i.e., more than a million shares held by nonaffiliated shareholders) to avoid excessive volatility upon selling their position. Thus, larger offerings tend to attract a greater mix of institutional investors. On the other hand, while retail investors can be a little more emotional in their trading, their individual decisions do not usually affect your company’s stock unless a significant number act within the same time frame.
The “letter of intent”
This is the first of several documents into which you will enter with your underwriter. As noted, though it is a signed document, it is not binding beyond the narrow expense provisions it delineates. The second document, which is binding, is the underwriting agreement. Under normal circumstances, it is not signed until within 24 hours of the expected effective date of the registration statement. By this time, the underwriter has received commitments or indications that are commonly well in excess of the offering size.
Between the time you sign the letter of intent and the underwriting agreement, your company will incur substantial expenses with no assurance that the offering will take place. This is not an idle observation. Stories about IPOs reaching the eleventh hour only to be withdrawn or delayed because market conditions have changed or the underwriter has reconsidered do exist.
The underwriting agreement
Underwriting agreements come in two basic types: “firm commitment” and “best efforts.”
Under a firm-commitment agreement, the underwriters pledge to buy all of the stock offered in the IPO and resell it to the public. This arrangement offers the company the most security because the owners know they will receive the full sales price of the issue. However, until the underwriter and the company establish the final pricing and execute the underwriting agreement, the only commitment on the line is the underwriter’s reputation.
In contrast, under a best-efforts commitment, the underwriter, using his best efforts to sell the stock, is under no obligation to purchase the stock should part of the issue remain unsold. An underwriter who considers the issue to be risky may choose this type of agreement to shift the risk to the company.
There are variations on these two basic agreements. An “all-or-none” commitment is a modification of the “best-efforts” agreement: All of the stock must be sold
by the underwriter or the entire issue is canceled (at considerable cost to the company). In a partial “all-or-none” agreement, the underwriter requires sale of a specified portion of the issue (typically two-thirds) for the “best efforts” to remain in effect on the remainder of the issue.

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