What is a 'Back Stop'

A back stop is the act of providing last-resort support or security in a securities offering for the unsubscribed portion of shares. A company tries to raise capital through an issuance, and to guarantee the amount received through the issue, it gets a back stop from an underwriter or major shareholder to buy any of the unsubscribed shares.

Explaining 'Back Stop'

For example, in a rights offering, you might hear "ABC Company will provide a 100% 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.

Back Stops as Insurance

While not an actual insurance plan, a back stop provides security through the guarantee a particular amount of shares will be purchased if the open market does not produce enough investors. By entering into a firm commitment underwriting agreement, the associated organization has claimed full responsibility for the quantity of shares specified if they initially go unsold, and promises to provide the associated capital in exchange for the available shares. This gives assurance to the issuer that the minimum capital can be raised regardless of the open market activity. Additionally, all risk associated with the specified shares is effectively transferred to the underwritten organization.

Share Ownership

If the underwriting organization takes possession of any shares, as specified in the agreement, the shares are its to manage as it sees fit, and are treated the same as any other investment purchased through normal market activity. The issuing company can impose no restriction on how the shares are traded. The underwriting organization may hold or sell the associated securities per the regulations that govern the activity overall.

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Further Reading

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