A back stop, in the realm of corporate finance and investment banking, refers to the provision of last-resort support or the commitment to bid in a securities offering for any unsubscribed portion of shares. This mechanism is crucial when a company seeks to raise capital through an issuance and wishes to ensure the receipt of a guaranteed amount. To achieve this, the company may secure a back stop from an underwriter or a major shareholder, such as an investment bank, who is willing to purchase any unsubscribed shares.
Key Takeaways:
Special Considerations: If the underwriting organization takes possession of any shares, as specified in the agreement, the shares belong to the organization to manage as it sees fit. The shares are treated the same way as any other investment purchased through normal market activity. The issuing company can impose no restrictions on how the shares are traded. The underwriting organization may subsequently hold or sell the associated securities per the regulations that govern the activity overall.
Example of a Back Stop: In a rights offering, you may see a statement to this effect: ‘ABC Company will provide a 100 percent back stop of up to $100 million for any unsubscribed portion of the XYZ Company rights offering.’ If XYZ is trying to raise $200 million, but only raises $100 million through investors, then ABC Company purchases the remainder. What Is a Back Stop in a Bond Issue?: Similar to the back stop in an equity placement, a back stop for a bond issue is a type of guarantee whereby the underwriting bank or syndicate will fix a price at which to purchase any unsold or unsubscribed bonds. Who Are Backstop Purchasers?: If the underwriting bank or investment banking syndicate cannot or do not want to back stop a new issue, third-party backstop purchasers may be called upon to step in and buy any unsubscribed portion of a securities issue. These purchasers may provide a bid substantially below the issue price and/or may demand fees as compensation. They would then often try to sell off the holdings over time at a profit. What Are Volcker Rule Backstop Provisions?: The Volcker Rule is a set of financial regulations that separates the commercial and investment banking activities of a firm. Its purpose is to prevent conflicts of interest and unfair practices to the detriment of a bank’s customers. One provision of the Rule is to prevent the backstopping of a securities issue by an underwriting bank if it will create a conflict of interest. Moreover, a back stop would be prohibited if it would ‘result, directly or indirectly, in a material exposure by the banking entity to a high-risk asset or a high-risk trading strategy; or pose a threat to the safety and soundness of the banking entity or to the financial stability of the United States.’