Bought deal financing is a type of financing commonly used by companies to raise capital quickly and efficiently. It involves the sale of securities, such as stocks or bonds, directly to an underwriter or investment bank, who then resells them to investors. This process allows the company to receive immediate funds, often at a fixed price, without the need to wait for the securities to be sold on the open market.
How Does Bought Deal Financing Work?
In a bought deal financing arrangement, a company looking to raise capital will approach an investment bank or underwriter. If both parties agree on the terms, the underwriter will purchase a predetermined number of securities directly from the company at a set price. The underwriter then assumes the risk of reselling these securities to investors at a higher price, hoping to make a profit.
The underwriter typically takes on the risk of the market value of the securities decreasing before they can be resold. This risk is known as “price risk.” However, the underwriter also has the potential to profit if the market value of the securities increases. The underwriter’s profit is essentially the difference between the price paid to the company and the price at which the securities are sold to investors.
Advantages of Bought Deal Financing
There are several advantages to using bought deal financing:
1. Speed and Efficiency: Bought deal financings allow companies to raise capital quickly and efficiently. Since the underwriter commits to purchasing the securities, the company receives immediate funds without the uncertainty of waiting for the securities to be sold on the open market.
2. Certainty of Funds: With a bought deal financing, companies have certainty of funds. They know the exact amount of capital they will receive from the underwriter, which can help with financial planning and executing business strategies.
3. Reduced Market Risk: By selling the securities directly to the underwriter, the company effectively transfers the market risk to the underwriter. This can be beneficial for companies that want to raise capital but are concerned about potential market fluctuations that could impact the value of the securities.
Disadvantages of Bought Deal Financing
While bought deal financing offers various advantages, there are also some disadvantages to consider:
1. Potential Undervaluation: Since the underwriter sets the purchase price, there is a possibility that the company may undervalue its securities. This could result in the company not receiving the full potential value for its securities.
2. Dilution of Ownership: When a company issues additional securities through bought deal financing, it may lead to dilution of ownership for existing shareholders. This means that each existing shareholder’s ownership percentage may decrease as new shares are issued.
Conclusion
Bought deal financing is a popular method for companies to raise capital quickly and efficiently. It involves selling securities directly to an underwriter, who then resells them to investors. This financing option offers advantages such as speed, certainty of funds, and reduced market risk. However, there are also potential disadvantages, including undervaluation of securities and dilution of ownership. Overall, bought deal financing can be a valuable tool for companies seeking to raise capital, but careful consideration of the terms and potential risks is essential.
