Selling a IPO by a Dutch Auction

In a hot IPO, when many investors are clamoring to get shares, many of those who do get the newly issued shares will flip it—immediately sell it in the open market for instant profits. The investment bank must, by law, sell the new shares at the offering price regardless of demand. Because of the demand for the new issues, they have to be allocated, and usually it's the biggest clients of the investment bankers who get the issue—small investors almost never get to participate. Furthermore, neither the investment bankers nor the issuer can profit from flipping. However, flipping is an indication that the offering price was set too low, but, on the other hand, the bankers don't want to set the price too high so that they can be sure to sell the entire issue quickly.

With a hot IPO, it is difficult to ascertain what price would be best, so some companies use a Dutch auction to determine the price. Google used this method for its IPO, for instance. In a Dutch auction, the public is invited to submit closed bids, indicating how many shares they want and at what price they are willing to pay. Then the company sets the offering price that will sell out the whole issue. Everyone who bid at or above the offering price will get shares at the offering price, even if they bid higher. 

Those who bid below the price will get no shares. In most cases, the successful bidders will not get all of the shares that they requested, because there will not be enough, so the shares will be allocated proportionally to the amount that they requested to the total amount requested. So, if the successful bidders requested 10,000,000 shares, but there are only 2,000,000 shares available, then each bidder will get 20% of whatever they requested.

Standby Commitment for a Rights Offering — Lay Off

When the investment bank also has a standby commitment with its client, then the investment bank agrees to purchase any subsequent new issues of stock shares at the subscription price that are not purchased by current stockholders in a rights offering, which it will then sell to the general public as a dealer in the stock.

The investment bank takes a risk, however, in that the price of the stock could decline during the 2 to 4 weeks of a rights offering. To minimize this risk, the investment bank may do a lay off:

buying up any rights that are sold by the current stockholders, then exercising the right and selling the stock; and by selling enough stock short, up to 1/2% of a new issue, to cover an expected proportion of unexercised rights, then using the rights to cover the short.

Best Efforts Underwriting

Most agreements for the sale of new securities are an underwriting, but sometimes the investment bank will agree to a best efforts approach because the company is perceived as a risky investment for a new issue. The investment bank will do its best to sell all of the new securities, but it does not guarantee it. The company bears the risk that the investment bank may fail to sell all of the new issue, thereby lessening the amount of money that the company receives.

There are 2 variations of the best-efforts underwriting: all-or-none or mini-max. An all-or-none underwriting requires that the entire issue be sold within a specified time, or else the program is terminated. A mini-max (aka part-or-none) underwriting is similar, except that only a specified minimum must be sold. In either case, SEC Rule 15c2-4 requires that all money collected from any sales be deposited in a separate escrow account at an independent bank for the benefit of the investors. If the sale is canceled, then the money must be returned to the investors, and no more orders will be taken; if the underwriting is successful, then most of the money goes to the issuer minus the fees paid to the underwriters.