Does the underwriter buy the deal or just sell it? That single fact decides who bears the loss on unsold shares.
- Firm commitment: underwriter buys the issue as principal and bears risk.
- Best efforts: underwriter sells as agent and returns unsold shares.
Who owns the shares nobody wanted
An underwriter can take one of two positions. In a firm commitment it buys the entire issue from the issuer at an agreed price and resells it to the public. It is acting as principal, it owns the securities in between, and if the market turns and the deal will not sell, the loss is the underwriter’s. The issuer knows exactly what it will receive the moment the agreement is signed.
Keep reading: 5 more paragraphs (about 3 min)
In a best efforts arrangement the underwriter never buys anything. It acts as agent for the issuer, uses its distribution network to place as much as it can, and hands back whatever it cannot sell. The issuer keeps the market risk and does not know its proceeds until the offering closes. Two variants make the sale contingent. In an all-or-none offering the buyers’ money is refunded unless every share sells at the stated price within the stated time; in a minimum-maximum (mini-max) offering it is refunded unless a stated minimum number of units sells by a deadline. SEC Rule 10b-9 makes it a fraud to describe an offering either way unless those refund conditions really apply.
The compensation follows the position. A principal earns the spread between what it paid the issuer and the public offering price. An agent earns a fee or commission on what it actually places. The prospectus must set out the underwriters’ discounts and commissions for each security and in total, and the discounts allowed to the dealers who help sell the issue, often called the selling concession.
Keep the type of offering separate from the type of commitment. An initial public offering is a company’s first sale of shares to the public. A follow-on primary offering sells newly created shares later, and the money goes to the company. A secondary offering sells shares already owned by existing holders, so the proceeds go to those sellers. Any of the three can be done firm commitment or best efforts.
It also helps to know who the statute counts as an underwriter, because the word is broader than the bank on the cover of the prospectus. An underwriter is any person who has purchased from an issuer with a view to the distribution of a security, or who offers or sells for an issuer in connection with a distribution, or who participates directly or indirectly in such an undertaking — and issuer here includes anyone controlling, controlled by, or under common control with the issuer. The exclusion is the part that protects the ordinary representative: the term does not include a person whose interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors’ or sellers’ commission. Selling the deal for a normal commission does not make you an underwriter; taking a position in it can.
A large issue is rarely sold by one firm. An underwriting syndicate is a group of underwriters that share the distribution of a single offering. One firm manages it, and each member takes part of the issue. SEC Regulation M counts a person who agrees to manage or supervise a distribution as an underwriter, and it refers to the underwriting syndicate or group acting together in the offering. The prospectus names the principal underwriters and the amount each has underwritten. The commitment type still decides the risk: in a firm commitment each syndicate member buys its share, and in a best efforts deal the members place what they can for the issuer.
Exam terms (7)
- Firm commitment
- The underwriter buys the issue as principal and resells it, bearing the risk.
- Best efforts
- The underwriter sells as agent and returns whatever it cannot place.
- All-or-none
- A best efforts variant: buyers are refunded unless every share sells at the stated price within the stated time.
- Underwriting spread
- The underwriters’ discount from the offering price, shown in the prospectus per security and in total.
- Selling concession
- The discount allowed to the dealers who sell the securities, which the prospectus must also state.
- Secondary offering
- A sale of shares owned by existing holders; the issuer receives nothing.
- Underwriting syndicate
- A group of underwriters, led by a managing firm, that jointly distributes one offering.
Principal or agent
| Firm commitment | Best efforts | |
|---|---|---|
| Underwriter acts as | Principal | Agent |
| Owns unsold securities | The underwriter | The issuer |
| Issuer knows proceeds | At signing | Only at closing |
| Underwriter is paid by | The spread earned on resale | A fee or concession on what it places |
| Market risk sits with | The underwriter | The issuer |
Try it: Read any deal description and stop at the first verb that describes the bank: purchases, or places. From that one word alone, answer three questions in order — who is left holding an unsold share, who knew the proceeds first, and does the bank earn a spread or a fee. Do it for both wordings before you look at the table again.
Check yourself
Try a question, then read the explanation to review the rule.
Opening your study record…
Worked example
Two banks bid for the same offering of 5,000,000 shares priced at $20, one proposing to buy the issue and the other to place it for a fee.
- The first bank offers to buy all 5,000,000 shares at $18.50 and resell them at $20. That is a firm commitment: the issuer is certain of 5,000,000 × $18.50, or $92,500,000, on signing.
- The bank’s pay is the spread of $1.50 a share, worth $7,500,000 if the whole issue sells at the offering price.
- Suppose demand collapses and only 4,000,000 shares sell at $20. The bank still paid for all five million, so it owns 1,000,000 unsold shares and must sell them for whatever the market will bear. The issuer is unaffected.
- The second bank offers best efforts at a fee of $1.00 a share placed. If the same 4,000,000 shares sell, the issuer receives 4,000,000 × $19.00, or $76,000,000, and the remaining 1,000,000 shares come back to it.
- The choice is a trade between certainty and cost. Firm commitment gives the issuer a guaranteed $92,500,000 and hands the downside to the bank; best efforts is cheaper per share placed but leaves the shortfall with the issuer.
Same rule, new context
Opening your study record…
The closest contrast
Firm commitment: principal.
Best efforts: agent.
The distinction decides any question that leaves shares unsold. Under firm commitment the underwriter already owns them and takes the loss; under best efforts they go back to the issuer, which simply raises less than it hoped.
Summary
- Firm commitment makes the underwriter a principal that owns the issue and any unsold part of it.
- Best efforts makes the underwriter an agent; unsold securities return to the issuer.
- A principal earns the spread; an agent earns a fee or a selling concession.
- Primary proceeds go to the issuer; secondary-offering proceeds go to the selling holders.
- A syndicate is several underwriters sharing one distribution under a managing firm.
Related practice
- Underwriting commitment and offering typePractice this
Sources
- SIE Examination Content Outline (2025) · FINRA · checked 2026-10-12
- 15 U.S.C. § 77b(a)(11) — Definition of "underwriter" (Securities Act section 2) · US Code · checked 2026-09-04
- Secondary Market (SEC Office of Investor Education and Advocacy) · Investor.gov · checked 2026-09-04
- 17 CFR 229.508 — Item 508, Plan of Distribution (Regulation S-K) · SEC · checked 2026-09-04
- 17 CFR 242.100 — Definitions (Regulation M) · SEC · checked 2026-09-29
- 17 CFR 240.10b-9 — Prohibited representations in connection with certain offerings (all-or-none and other contingency offerings) · SEC · checked 2026-10-10
- 17 CFR 229.508(e) and (h) — Regulation S-K Item 508, underwriter's and dealers' compensation · SEC · checked 2026-10-10