Underwriting Spread

An underwriting spread is the difference between what underwriters (typically investment banks) pay an issuing company for its securities and the price at which those securities are sold to the public. It represents the underwriter’s gross profit margin and is commonly expressed as a percentage or as points per share/unit.

Key takeaways

• The spread equals the underwriter’s purchase price paid to the issuer subtracted from the public offering price.
• It is the underwriter’s gross revenue before deducting marketing, distribution, and other offering-related costs.
• Spread size varies by deal, influenced by risk, expected demand, deal size, and syndicate negotiations.

Components of an underwriting spread (typical for an IPO)

The underwriting spread frequently includes three components:
* Manager’s fee — earned by the lead manager(s) who organize and coordinate the offering.
* Underwriting fee — shared among members of the underwriting syndicate.
* Selling concession — paid to broker-dealers that sell the shares.

Allocation:
* The lead manager often takes the manager’s fee and a portion of the underwriting fee.
* Syndicate members split the underwriting fee and parts of the concession (not always equally).
* Non-syndicate broker-dealers may earn selling concessions based on their sales performance.

What determines the spread size

Spread size is negotiated on each deal and depends mainly on:
* Perceived underwriting risk (higher risk → larger spread).
* Expected market demand for the securities.
* Deal size and economies of scale: fixed work (prospectus preparation, roadshows) means larger deals don’t proportionally increase management effort, so the relative share of fixed fees may shrink while selling concessions (sales effort) can grow.
* Market volatility and the number/type of banks in the syndicate (junior banks may accept smaller fee shares to participate).

Example

If an issuer receives $36 per share from the underwriter and the underwriter sells the shares to the public at $38, the underwriting spread is $2 per share.

Bottom line

The underwriting spread is the underwriter’s upfront gross compensation for taking on issuance and distribution risk. It varies by transaction and is later offset by marketing, distribution, and other offering expenses when calculating net proceeds and the underwriter’s net profit.