Standby underwriting

Standby underwriting is a type of firm commitment underwriting used specifically with rights offerings. When a corporation raises capital by offering new shares to its existing shareholders first, some shareholders inevitably decline to exercise their rights. Under a standby arrangement, the underwriter "stands by" and purchases all unsubscribed shares, then resells them to the public.

Here is how it works in practice: a company offers 1 million new shares to current shareholders through a rights offering. Shareholders subscribe to 800,000 shares, leaving 200,000 unsold. The standby underwriter buys those remaining 200,000 shares at the subscription price, taking them into its own inventory. The issuer receives the full proceeds of the offering regardless of shareholder demand.

The key feature is who bears the risk. Because the underwriter commits to buying whatever shareholders leave behind, standby underwriting is a form of firm commitment — the underwriter, not the issuer, assumes the risk of unsold shares. This contrasts with best efforts underwriting, where the underwriter acts only as an agent and returns unsold shares to the issuer.

The Series 6 and Series 7 exams test standby underwriting in the primary market material. Remember the pairing: standby underwriting goes with rights offerings, and it is a firm commitment arrangement. If a question describes an underwriter purchasing shares that existing shareholders declined to buy, standby underwriting is the answer.