How is an IPO gross spread split among the underwriters?

The spread divides into three parts, and each part is shared among the banks on a different key.

Julian R. Sterling · from Capital Markets

An IPO gross spread is split into three parts, by a common convention 20 per cent management fee, 20 per cent underwriting fee and 60 per cent selling concession, and each part is divided among the banks on a different key. On an illustrative $600.0 million IPO with a 5.0 per cent spread, the $30.0 million becomes $6.0 million, $6.0 million and $18.0 million, and the lead-left bank with 35 per cent of the underwriting ends up with $10.275 million, 36.1 per cent of the fees actually distributed.

Worked in full in Capital Markets by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

The prospectus shows one number: the underwriting discount per share. Behind it sits a split the issuer never sees in detail but which drives everything about the syndicate, from which bank fights for the left-hand position on the cover to why co-managers accept small allocations. The arithmetic is simple once each component is matched with the key that divides it.

The assumptions

Illustrative IPO, $m unless stated. Syndicate terms are illustrative.
Input	Value
Shares offered, millions	30.0
Offer price, $	20.00
Gross spread, % of gross proceeds	5.0%
Split: management fee / underwriting fee / selling concession	20 / 20 / 60
Syndicate expenses charged to the underwriting fee	1.5

The syndicate.
Bank	Role	Underwriting commitment	Management fee share
Bank A	Lead-left bookrunner	35%	40%
Bank B	Bookrunner	30%	35%
Bank C	Bookrunner	20%	25%
Bank D	Co-manager	8%	0%
Bank E	Co-manager	7%	0%

The calculation, step by step

Step 1: the gross spread

Gross proceeds = 30.0m × $20.00 = 600.0
Gross spread = 5.0% × 600.0 = 30.0, or $1.00 a share; the issuer receives 570.0

Step 2: the three components

Management fee = 20% × 30.0 = 6.0 ($0.20 a share), paid to the managers for structuring and running the deal
Underwriting fee = 20% × 30.0 = 6.0 ($0.20 a share), paid for the underwriting commitment
Selling concession = 60% × 30.0 = 18.0 ($0.60 a share), paid for placing the shares

Step 3: each component on its own key

Management fee: by the agreed management shares, here the bookrunners only.
Underwriting fee: net of syndicate expenses, 6.0 − 1.5 = 4.5, by underwriting commitment. Stabilisation losses, if any, are also charged here.
Selling concession: by the agreed economics. With fixed economics, as here, it follows the underwriting commitments.

Step 4: Bank A

40% × 6.0 + 35% × 4.5 + 35% × 18.0 = 2.40 + 1.575 + 6.30 = 10.275

Excel, per bank: =MgmtFee*MgmtPct+(UWFee-Expenses)*UWPct+Concession*ConcPct

The result: who earns what

Fixed economics. Distributed fees total 28.5 after 1.5 of expenses.
Bank	Management	Underwriting	Concession	Total	% of distributed	$ per share offered
Bank A	2.40	1.575	6.30	10.275	36.1%	0.343
Bank B	2.10	1.350	5.40	8.850	31.1%	0.295
Bank C	1.50	0.900	3.60	6.000	21.1%	0.200
Bank D	0.00	0.360	1.44	1.800	6.3%	0.060
Bank E	0.00	0.315	1.26	1.575	5.5%	0.053
Total	6.0	4.5	18.0	28.5	100%	0.95

Every bookrunner earns more than its underwriting share, because the management fee is kept among them: Bank A holds 35 per cent of the risk and takes 36.1 per cent of the fees. The co-managers earn less than their commitments, 6.3 and 5.5 per cent against 8 and 7. The expenses fall on the underwriting fee, so they are borne in proportion to commitment: $0.525 million of Bank A's share.

What if: jump ball instead of fixed economics

Under a jump ball, the selling concession is credited by investor designations: each investor names the bank that should be paid for its order. Suppose the designations credit Bank A with 50 per cent of the concession, Banks B and C with 30 and 20, and the co-managers with none.

Total fees by bank, $m, fixed economics against a jump ball.
Bank	Fixed economics	Jump ball	Change	% of distributed, jump ball
Bank A	10.28	12.98	+2.70	45.5%
Bank B	8.85	8.85	0.00	31.1%
Bank C	6.00	6.00	0.00	21.1%
Bank D	1.80	0.36	−1.44	1.3%
Bank E	1.58	0.32	−1.26	1.1%

Because the concession is 60 per cent of the spread, the designation mechanism moves more money than any other term. A bank with strong institutional distribution prefers a jump ball; a co-manager on a jump-ball deal underwrites 8 per cent of the risk for 1.3 per cent of the fees. That is why the economics are negotiated as hard as the titles. If the over-allotment option is exercised, the 4.5m extra shares add $4.5 million of spread split on the same keys, $1.62 million of it to Bank A under fixed economics; the mechanics are in how a greenshoe option works.

The common mistakes

Equating fees with commitment. A bank's fee share is a blend of three keys, not its underwriting percentage. Here the lead-left earns 36.1 per cent of distributed fees on a 35 per cent commitment, and 45.5 per cent under a jump ball.
Treating the spread as the issuer's whole cost. The spread is the visible fee, deducted from the proceeds. Underpricing usually costs more; the full calculation is in the true cost of an IPO.
Forgetting the underwriting fee is a residual. Expenses and any stabilisation loss come out of it first. On a deal that trades badly, the underwriting fee can be wiped out while the concession is still paid.
Assuming the 20/20/60 convention. It is a starting point. Some deals shift weight to the management fee; European offerings often add a discretionary incentive fee paid at the issuer's choice.

Takeaway

Split the spread into its three parts, then divide each on its own key: management shares, underwriting commitments net of expenses, and the agreed or designated concession. On $30.0 million of spread, that gives the lead-left $10.275 million under fixed economics and $12.975 million under a jump ball. The book's offering costs, placings and pricing conventions are worked in the free Capital Markets workbooks.

Questions readers ask

What are the components of an underwriting gross spread?

The management fee, for structuring and running the deal; the underwriting fee, for taking the commitment and absorbing expenses and stabilisation losses; and the selling concession, for placing the shares. A common split is 20/20/60: on a $1.00 per share spread, $0.20, $0.20 and $0.60.

What is the difference between fixed economics and a jump ball?

Under fixed economics the selling concession is split by pre-agreed percentages, often the underwriting commitments. Under a jump ball it follows investor designations. In the illustrative deal, a lead-left credited with 50 per cent of designations earns $12.98m instead of $10.28m, while a co-manager with an 8 per cent commitment falls from $1.80m to $0.36m.

Who pays the syndicate expenses in an IPO?

The underwriters, out of the underwriting fee, before it is split by commitment. With $1.5m of expenses against a $6.0m underwriting fee, $4.5m is left to share, and the lead-left with 35 per cent bears $0.525m of the expenses. The issuer's own legal, audit and listing costs are separate and paid by the issuer.

Read the whole case

This article is one calculation from Capital Markets. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.

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