What is Bought out Deals? Advantages, Disadvantages

What is Bought out Deals?

A bought deal is an issue of new shares that is purchased by a single underwriter, with the intent of reselling those shares to investors. Often, the underwriter involved in the transaction is an investment bank or some type of investing syndicate.

The general strategy of the bought deal calls for securing the shares associated with the offering at a discounted price, then reselling the acquired shares at the current market value, a move that provides the underwriter with a significant opportunity to earn a return on the deal.

There are a few key advantages associated with a bought deal. For the entity that issues the shares, there is no need to be concerned about financing risk. Since all the shares are sold up front, earning a return is assured. In situations where the offering of new shares was intended to generate capital that the issuer needs now rather than later, this means no waiting, and no speculation about how long it will take for the shares to sell.

The buyer or underwriter also benefits from the bought deal strategy. Often, the discount applied to this type of volume purchase is significantly more than with fully marketed offerings, where an underwriter must actively market the shares to potential investors in order to set the purchase price. This means that the underwriter gets the shares at an excellent price and stands to earn a great deal of money from the resale of the shares.

Advantages of Bought out Deals

Bought out deals is not only advantageous to the going for it but also it is advantageous to the sponsor and common investors. Following are the various advantages of Bought out deals.

• Speedy sales: Bought out deals offer a mechanism for speedier sales of security at a lower cost relating to issue.
  
  
• Freedom in price setting: Bought out deals offer freedom for promoters to set a realistic price and convince the sponsor about the same.
  
  
• Investors Protection: Bought out deals facilitate better investor protection as sponsors are rigorously evaluated and appraised by the promoters before offloading the issue.
  
  
• Quality offer: bought out deals helps to enhance the quality of capital flotation and primary market offering

Disadvantages of Bought out Deals

• Loss of control: The apprehension in the mind of promoters particularly of the private or closely held companies that the sponsors may take control of the company as they own large portion of the share of the company.
  
  
  
• Loss of sales: Bought out deals pose considerable difficulty in off-loading the shares in time of unfavourable market conditions thus results in locking up of investments and entailing losses to sponsor.
  
  
• Manipulation: Bought out deals gives great scope for manipulation at the hands of sponsor through insider trading.