how a back stop works
a back stop functions as a form of insurance while not an actual insurance plan a company can guarantee that a certain amount of its offering will be purchased by particular organizations usually investment banking firms if the open market does not produce enough investors and a portion of the offering goes unsold if the organization providing the back stop is an investment banking firm sub underwriters representing the investment firm will enter into an agreement with the company this agreement is referred to as a firm commitment underwriting deal or contract and it provides overall support for the offering by committing to purchase a specific number of unsold shares 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 if all of the offering is purchased through regular investment vehicles the contract obligating the organization to purchase any unsold shares is rendered void as the conditions surrounding the promise to purchase no longer exist the contracts between an issuer and the underwriting organization can take various forms for example the underwriting organization can provide the issuer with a revolving credit loan to boost credit ratings for the issuer they may also issue letters of credit as guarantees to the entity raising capital through offerings special considerationsif 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 stopin 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 