The Series 7 underwriting spreads section is full of confusing jargon. Takedowns here, additional takedowns there, liability, concessions, and so much more. Today we will try to shed some light on a foggy subject.
When studying for the Series 7 exam a translator would be a nice help. But, since we don’t know a good translator, we thought we would take a crack at it ourselves. In this post we clarify a few terms that provide some trouble for a lot of folks.
Series 7 Underwriting Spreads: What is the Underwriter?
First, it’s good to get clear on what some of the above words mean. You can associate the idea of an “underwriter” with that of a backstop. The underwriter provides the issuer (e.g., the corporation looking to raise money) with the necessary funds to go public. They do this by either buying up all of the offering themselves (which they will then sell to investors for a slight mark up), or by facilitating the transaction that will enable the issuer to sell its offering (and charge a commission).
This investment banker, or underwriter, role in the capital markets industry is critical. It helps issuers get cash that they need to expand and/or grow. That said, such a service can be lucrative. The fees are often quite high, and involve several layers.
Let’s uncover and define those layers, that make up the underwriting spread for the Series 7 exam.
Components of the Underwriting Spread
Concession: The “Concession” is typically the largest component of the underwriting spread. Often this portion of the fee is what goes to compensate the sales associates that help sell the securities of the new issue. The fee comes from the fact that the investment bank (e.g., the underwriter) may purchase the securities from the issuer at a discount, and then sell them to investors at full price. It can help to sometimes think of this part of the underwriting spread as similar to a commission.
Additional Takedown: The “Additional Takedown” can be thought of as a fee paid to the underwriter for taking on the risk of buying the securities from the issuer. Imagine a situation where the investment bank pays an issuer for its securities with the intention of selling these securities the next day to its clients (e.g., hedge funds, pension funds, etc.) via an IPO. If there is some major market meltdown overnight, and the next day the securities cannot be sold, then the investment bank is stuck “holding the bag.” The fee for this additional risk can sometimes be know as a fee paid for “liability.”
Manager’s Fee: The “Manager’s Fee” is the fee paid to the “lead underwriter.” In other words, the one investment bank that is chosen among a group of investment banks to manage the deal. Often when a deal is being taken to market multiple investment banks will be involved with the transaction. One will be designated as the lead. This investment bank is paid a fee above and beyond the concession and additional takedown for the simple fact that they may be in charge of organizing and/or helping manage the deal. They may also be tasked with managing the other investment banks in the deal.
Formulas
Lastly, you should know one more thing when it comes to the Series 7 underwriting spreads section. The formulas that go with this section:
Underwriting Spread = Concession + Additional Takedown + Manager’s Fee
Total Takedown = Concession + Additional Takedown
Net Proceeds to Issuer = Amount Issued – Underwriting Spread
Although these formulas may not get tested extensively, they represent quick and easy points you can get when they come up. Try squaring away the jargon in this section and it will help quite a bit.
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