What is a Backstop in a Security Offering?

In the investment industry or stock market, a backstop is the last support or security provided for newly issued securities or shares that are being offered in a particular transaction. Newly issued shares that have less interest or subscriptions are regarded as unsubscribed shares. Investors or companies who want to purchase shares of this nature get a backstop from an underwriter or an investment bank before making the purchase. The backstop guarantees the payment for unsold portion of the offering.

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How does a Back Stop in a Security Offering Work? 

A backstop is a type of insurance used in securities offering to guarantee that a portion of shares (unsubscribed) will be purchased by a party, usually an underwriter or an investment bank. It is often called the last-resort support provided for the offering on unsubscribed shares in the stock market. The provision of a backstop is often contained in an underwriting contract. 

A company who wants to raise funds from the purchase of unsubscribed portion of shares goes to an underwriter or investment banking firm to get a backstop. If the company is unable to sell a portion of the offering in the open market, the underwriter or investment bank is obliged to purchase the remaining portion.

Back Stops as Insurance

A backstop is not an insurance policy but it works as a form of insurance in securities offering for the unsubscribed portion of shares. A backstop offers guarantee that an underwriter or investment bank who provides a back stop will purchase a portion of an unsold shares from the investor who holds the backstop. 

For example, if Company A wishes to raise a capital of $500 through the sales of a number of shares in the open market but is able to raise only $300, the underwriter who provided the backstop will purchase the remaining number of shares so that Company A would realize the desired $500. Also, the underwriter or investment bank that provides a backstop is liable for all the risks associated with the shares.

Share Ownership

Any number of shares purchased by an underwriting organization or an investment banking firm under a backstop contract is owned and managed by the firm. The treatment meted out to other shares purchased in the normal market are applicable to shares purchased under a backstop contract. Once an underwriter, or investment banking organization purchases the remainder shares unsold on the open market, the issuing company no longer has claim to the ownership of the shares. The treatment of the shares or how they are traded can also not be determined by the issuing company, instead, the underwriting company or investment banking firm take charge of the shares.

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