Backstop_Purchaser

Key Takeaways

• A backstop purchaser guarantees the purchase of all remaining unsubscribed securities from a rights offering.
• They act as a form of insurance for companies, ensuring capital requirements are met.
• Backstop purchasers charge a premium for the risk they take on.
• Rights offerings involve multiple rounds with existing shareholders before backstop purchasers step in.
• Having a backstop purchaser can be costly but provides security if shareholder interest is low.
• Get personalized, AI-powered answers built on 27+ years of trusted expertise.

What Is a Backstop Purchaser?

A backstop purchaser, also called a standby purchaser, agrees to buy any unsubscribed securities in a company’s rights offering so the issuer can still raise the targeted capital. It functions like financial insurance for a fee, since it guarantees that the remaining shares will be purchased. The tradeoff is higher costs and possible dilution or added influence for the backstop provider.

Role and Process of a Backstop Purchaser

Backstop purchasers are a form of standby underwriting, where one or more investment banks enter into an accord with a company and agree to publicly sell any of its unsubscribed shares for a price generally no less than the subscription price associated with the rights offering. In the case of backstop or standby purchasers, the party agrees to go a step further and buy all of the leftover, unsubscribed shares themselves.

The backstop purchase generally comes after three preceding rounds of rights offering. In the first round, the company offers existing shareholders the opportunity to purchase its stock at a discount to the market price. In the second round, it will proceed to offer its investors the right to buy any additional shares that remain unsubscribed. Then, in the third round, the company enters into an underwritten agreement, where one or more underwriters have agreed to purchase any shares not taken up in the rights offering, including in the oversubscription, for resale to the public.

The New York Stock Exchange (NYSE) views this round as a public offering for cash only if marketing efforts are made to a large group of potential purchasers and if shares are bought by a least some of these potential buyers. If, after all these options have been exhausted, there are still no takers, a fourth-round kicks in, during which backstop purchasers are permitted to buy up to 19.9% in the aggregate of the shares of common stock prior to the rights offering.

Important

Backstop purchasers are usually called on after other underwriting parties have failed to sell all of the shares at a discount to the public.

Rights offerings are considered normal business practices and are not subject to shareholder approval. Insured rights offerings differ somewhat, with their additional fundraising rounds attracting scrutiny.

Essential Requirements for Backstop Purchasers

There is no broker‐dealer licensing requirement for backstop purchasers, but most do have such a license as they are usually investment banks or underwriting syndicates.

Backstop purchasers may face constraints, however, if they are related parties: directors, officers, five-percent shareholders, or any person or company affiliated with those position-holders. Should one or more substantial investors agree to act as a backstop purchaser, they are not allowed to engage in activities to mitigate the risk of an under‐subscription, nor charge a fee.

In addition, if the related party wants to participate in other rounds of the offering, they must sit out one of the rounds. They are also required to buy the shares in the standby purchase on the same terms offered to existing shareholders in the rights offering.

Advantages and Disadvantages of a Backstop Purchaser

An issuer might consider a standby offering and backstop purchaser if they need to raise a specific amount of capital. That said, when calculating the number of share sales necessary to bring in the required funds, an issuer should factor backstop fees into the offering amount.

Backstopping can be costly and backstop purchases are often paid a premium in return for the risks they take on. For instance, in 2006, when Warren Buffett's Berkshire Hathaway Inc. (BRK.B) acted as a backstop purchaser for building materials company USG Corp. (USG), it earned a non-refundable fee of $67 million for the service.1

Fast Fact

Backstop compensation is generally a flat standby fee plus a per-share amount.

An issuer might also consider a standby rights offering if the stock price is volatile. Because the offering period is anywhere from 16 to 45 days, shareholders have plenty of time to decide whether they will exercise their rights and subscribe based on the price of those shares trading in the market, which could be the same or less than the subscription price.

The issuer doesn't want to set the subscription price too low but must consider the possibility that shareholders will balk. A backstop purchaser is an attractive mitigating force in this event.