Definition of “Bought Deal”
A bought deal is a mechanism used by publicly traded companies to raise capital. In this model, the company arranges to sell its new shares to an underwriter – often an investment bank or a market maker – who buys the entire block of shares outright. The underwriter then resells these shares to investors in the market, typically with the expectation of making a profit from the spread between the purchase price and the eventual selling price. This method is used as an alternative to a rights issue or placing.
Key Points:
- Capital Raising: A bought deal is particularly useful for swift capital raising.
- Immediate Securement: The company secures the funds immediately upon selling the shares to the underwriter.
- Risk Transfer: The risk of finding buyers is transferred from the issuing company to the underwriter.
Examples of Bought Deals
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Example 1: Company A and Investment Bank B: Company A needs to raise $100 million for an acquisition. Instead of issuing a rights issue to its current shareholders, it approaches Investment Bank B. Bank B buys the $100 million worth of shares at a discount and then sells these shares to various investors, hoping to profit from the sale.
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Example 2: Rapid Capital Injection: A biotechnology firm, needing a rapid infusion of capital to continue its research, engages in a bought deal with a large market maker. This allows the firm to quickly secure funding without going through the longer process of a rights issue.
Frequently Asked Questions (FAQs)
Q1: What are the benefits of a bought deal for a company?
A1: The primary benefits include instant capital without the delay of market processes, reduction of market risks, and potentially less dilution for existing shareholders compared to other methods.
Q2: Why are bought deals controversial?
A2: They can be controversial because they go against the principle of pre-emption rights, which give existing shareholders the first right to purchase new shares. This bypass can disenfranchise current shareholders who do not get an opportunity to maintain their proportional ownership.
Q3: How does an underwriter benefit from a bought deal?
A3: An underwriter profits from the price difference between the bulk purchase price paid to the issuing company and the higher price at which the shares are sold in the open market.
Q4: In which regions are bought deals most prevalent?
A4: Bought deals originated in the USA but have become increasingly prevalent in the UK and other regions. They are gaining popularity owing to their efficiency, despite their controversial nature.
Q5: How does a bought deal differ from a rights issue?
A5: Unlike a rights issue, which offers new shares to existing shareholders first, a bought deal involves selling all shares to an underwriter directly, who then sells them to the general market.
Related Terms
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Rights Issue: A rights issue is an invitation to existing shareholders to purchase additional new shares in the company, typically at a discount to the current market price, to raise capital.
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Placing: In a placing, new shares are directly sold to institutional investors, often without offering them to existing shareholders first, to quickly raise funds.
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Competitive Bought Deal: A variant wherein multiple underwriters bid for new shares, and the company sells to the highest bidder.
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Vendor Placing: New shares are sold to institutional investors, with the funds going to an existing shareholder (the vendor) instead of the company.
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Pre-emption Rights: The right of existing shareholders to have the first opportunity to buy new shares before they are offered to the public, preserving their proportional ownership.
Online Resources
Suggested Books for Further Studies
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Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions by Joshua Rosenbaum and Joshua Pearl: This book provides a comprehensive overview of investment banking, including equity financing methods like bought deals.
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Corporate Finance by Stephen A. Ross, Randolph W. Westerfield, and Jeffry Jaffe: A thorough textbook covering various methods of corporate financing, including bought deals and other capital raising strategies.
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Foundations of Finance by Arthur J. Keown, John D. Martin, J. William Petty, and David F. Scott: This book details foundational concepts in finance, such as equity issuance methods and investment analysis.
Accounting Basics: “Bought Deal” Fundamentals Quiz
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