In investment banking, an underwriter facilitates the issuance and distribution of securities (such as stocks or bonds) to investors. Underwriters are typically large financial institutions or investment banks that work with companies (issuers) seeking to raise capital through the public or private markets.

Key functions of an underwriter are:

1. Advisory Role

• Underwriters help companies assess the best way to raise capital, whether through an Initial Public Offering (IPO), a secondary offering, or a debt issuance.
• They provide strategic advice on the timing, structure, and pricing of the securities based on market conditions, investor appetite, and the issuer’s needs.
• Underwriters also help in preparing the necessary regulatory filings, such as the S-1 registration statement with the SEC (in the U.S.) for an IPO.

2. Due Diligence

• Before the securities are offered, underwriters conduct a thorough due diligence process to evaluate the company’s financial health, business model, and risks. This includes reviewing financial statements, management practices, and market conditions.
• They ensure that the issuer complies with legal and regulatory requirements and that all material information is disclosed to potential investors.

3. Pricing and Structuring the Offering

• Underwriters determine the appropriate price for the securities being issued. This involves analyzing market conditions, comparable companies, and investor demand to set a price that balances the interests of the issuer (who wants to raise as much capital as possible) and the investors (who want a fair deal).
• They may also help structure the offering, deciding on the number of shares or bonds to be issued, the maturity dates, interest rates (for bonds), and any other relevant terms.

4. Underwriting the Offering (Risk Bearing)

• Underwriters often commit to purchasing the securities from the issuer and reselling them to investors. This is referred to as a “firm commitment” underwriting.
• In a firm commitment offering, the underwriter assumes the risk of selling the securities at the agreed price. If the securities cannot be sold to investors at the expected price, the underwriter may incur a loss.
• Alternatively, in a “best efforts” underwriting, the underwriter does not assume the risk of unsold securities but agrees to use its best efforts to sell the securities at the best possible price.

5. Marketing and Distribution

• After pricing, underwriters lead the roadshow, where company executives meet with institutional investors to generate interest in the securities. They market the offering and gauge investor demand.
• The underwriters then manage the actual distribution of the securities, working with brokers, dealers, and institutional investors to place the securities with the public.

6. Stabilization and Post-Issue Support

• After the offering, underwriters may engage in market stabilization activities to support the price of the securities in the secondary market, particularly if the price drops below the offering price. This is done by purchasing securities in the open market to maintain orderly trading.
• They also help ensure liquidity and provide after-market support, which might involve creating a secondary market for the securities.

7. Fees and Compensation

• In return for their services, underwriters typically earn a fee, which is a percentage of the total capital raised. This fee is typically higher for more complex or risky offerings.
• The underwriter’s compensation is often tied to the success of the offering, so they have a vested interest in ensuring it is priced and marketed well.

In essence, underwriters serve as intermediaries who help ensure that both the issuing company and the investors are well-served throughout the process of raising capital. Their role is integral to the functioning of the capital markets, as they bridge the gap between companies seeking funds and investors willing to provide them.