How it works (Example):
Company XYZ is issue 10 million shares in an initial public offering. Its , Bank ABC, agrees to underwrite the IPO. Bank ABC creates a document detailing Company XYZ's , financial forecasts, and the terms of the offering, and it meets with potential investors to gauge their interest in purchasing the shares. After this process is over, Bank ABC has agreements to sell the shares for $25 per share.. It plans to
However, Bank ABC also comes to a special agreement with John Doe, a wealthy investor, who agrees to be Bank ABC's back-stop purchaser. If for some reason Bank ABC can't sell all the shares in the IPO (this is called the unsubscribed portion), John Doe agrees to buy those leftovers. John Doe, of course, obtains a fee for agreeing to be the because he is taking on the risk of having to purchase (and then trying to reissue) the Company XYZ securities.