What is a Back Stop?
How Does a Back Stop Work?
For example, let’s assume that Company XYZ is issue 10 million in an initial public . Its investment bank, Bank ABC, agrees to underwrite the IPO. Bank ABC creates a document detailing Company XYZ’s , financial forecasts and the terms of the , and it meets with several potential investors to gauge their interest in purchasing the . After this process, Bank ABC has agreements to sell all 10 million for $25 per share.
However, Bank ABC also comes to a special agreement with John Doe, a wealthy investor, who agrees to be Bank ABC’s back stop. If for some reason Bank ABC can’t sell all the in the IPO (this is called the unsubscribed portion), John Doe agrees to buy those leftovers. John Doe, of course, obtains a fee for agreeing to be the back stop because he is taking on the risk of having to purchase (and they trying to reissue) the Company XYZ securities.