All About Back Stop

Before we dive into the world unsubscribed share and backstop let's take a look at the types of shares within the stocks and investment sector, specifically the authorized and issued, subscribed and unsubscribed shares.

1. Authorized Share Capital

This is the amount of capital a company accepts from investors through the sale of shares. These numbers are listed in the company's official documents. The Authorized share amount is indicated in the Memorandum of Association (MOA).

2. Share capital is issued

The issue of shares is a subset or Authorised shares that has been sold to the public. The act of issuing Issued Shares is called Issuance or allotment.

3. Subscribed Capital

Subscribed capital is a subset Issued share capital. It denotes how many shares the public has purchased. The public is not required to take all of the issued shares.

Let's say that ABC is planning to go public. The company plans to issue a total number of 20,000 shares as part of an initial public offering (IPO) at Rs.100 per share. The public will be able to purchase 16,000 shares after the IPO is completed.

Issued Shares = 20,000

Subscribed shares = 16,000

Unsubscribed shares = 4,000

These extra shares can be sold by company ABC, but there is no guarantee they will sell completely. Company ABC may want to sell these extra shares, but there is no guarantee that they will be sold out completely.

What is backstop?

Backstops are financial arrangements that provide a second source of funds in the event the primary source does not meet the needs. This can be described as an insurance policy that protects the buyer of unsubscribed shares. It guarantees the purchase by an investment bank or underwriter of any remaining unsubscribed shares. This is a last-resort support type, but only for transactions on unsubscribed shares. When a transaction is made on unsubscribed shares, the issuing company (or the buyer) enters into a contract with the provider.

If all shares offered are sold to the public via regular investment vehicles, the contract obligated the provider to purchase unsold shares will be null and void.

Backstop meaning

Backstop is a term used in stocks and investments to describe the support that was provided for unsubscribed shares. As mentioned, unsubscribed shares are shares that have not been issued. Investors (buying parties) and companies that wish to invest in these shares can request a backingstop from the provider before they make the purchase. It is also possible to request a backstop from an organization if the issuing company wants to sell them. The backstop guarantees payment for any shares that are not sold.

What does a backstop do?

Let's say that a company is looking to raise additional funds and wants to offer its unsubscribed shares for sale to the public. To get a backing for these shares, the company contacts an underwriter or investment bank (providing organisation). The providing organization must buy the remaining shares if a portion of the unsubscribed shares are not used by the public.

Let's take this example one step further. We have 4,000 shares that are unsubscribed at Rs.100 each. The company has 4,000 unsubscribed shares worth Rs.100 each. The company contacts a provider organization to enter into a backstop agreement. The providing organization assumes all risks associated with the sale of these shares.

Out of the 4,000 shares, 3,000 were sold to the public and the remaining 1,000 shares valued at Rs. The providing organization purchases 1 lakh shares.

The providing organization owns and manages any number of shares that it has purchased under the backstop contract. The issuing company loses all rights to those shares once the providing organisation has bought the unsold backstop shares. These shares can be treated as they wish by the issuing company. These shares are under the total control of the providing company and they can be traded or treated as they wish according to the overall regulations.

Depending on the context, a backstop can take many forms. These are the possible forms of a backstop.

1. Backstop in underwriting

This is the most popular form of backstop. It is used in cases such as underwriting issued shares during an IPO. An IPO's purpose is to raise funds through the sale of its shares to public. An underwriter provides backstop provisions under which the underwriting company is required to purchase all shares remaining that have not been sold to the public. This fee is calculated as a percentage from the total number of shares.

2. Private Equity Support

A private equity firm may wish to purchase another company. Typically, it will use the Leveraged Buyout approach. This involves financing the purchase with a lot of debt and then using equity.

If the funding is not sufficient, another private equity firm may enter into an agreement where it will provide equity funding to cover the shortfall.

3. Backstop for Financial Management

A revolving credit facility is another form of financial backstop that can be used to support a company's financial management. This is a short-term loan arrangement that allows the borrower to borrow a specific amount, up to a predetermined maximum, for a period of one year or less.

The revolving credit facility is a way to meet short-term funding needs.

Conclusion

A backstop acts as insurance. It is a guarantee that the company and its investment bank will raise the funds they intend to raise.