What Does Bought Deal Mean?
A bought deal is a type of financial agreement where the investment banker handling the initial public offering (IPO) of a company agrees to buy the entire IPO for a certain sum of money. In this deal, the financial risk for the company is greatly reduced as the amount of money it plans to raise through the IPO is known and would be obtained. However, the downside is that the company will potentially take a lower price for its shares if the IPO opening price ends up being higher.
Divestopedia Explains Bought Deal
A bought deal is less risky for the company that is looking to sell its shares in the market for the first time and, at the same time, is riskier for the investment banker as the onus is on them to sell all the shares to other investors in the open market. There is always a possibility that the investment bank may not be able to sell all the shares, or the value of shares can go down even before it is sold to investors. Moreover, the capital of the investment bank gets locked up in these unsold shares, making it unable to be put to better use.
To mitigate this risk and make up for possible losses, the investment bank will attempt to negotiate a huge discount at the time of buying the shares from the company. The company that is selling the shares may agree to a discounted value because of the reduced risk associated with the offering. It gets the money it wants for its business from the investment bank. For example, if the anticipated offering price of a share is $10, then the investment bank may negotiate for a $6 or $7 value per share for the bought deal, depending on the financial abilities of the company. The remaining few dollars on each share is the profit for the investment bank and most likely makes up for the loss that comes from the unsold shares.
In some cases, an investment bank may bring in other banks to form a syndicate so that the risk is divided among them. This strategy is implemented only when the deal is large enough and comes from reputable companies.