What is Back Stop?
February 15, 2023
In the world of stocks and investments, there are many different sorts of shares, including issued, authorized, and subscribed shares. Before we get into the realm of unsubscribed shares and backstop, let's first go through the many types of shares that are available.
- Issues Share Capital - Authorized shares that have been sold to the public are known as issued shares. Issuance, allotment, or allocation refers to the act of issuing issued shares.
- Authorized Share Capital - It refers to the total capital received by a corporation from investors through the sale of shares. These are listed in the official documents of the company. A company's MoA specifies the number of authorized shares.
- Subscribed Share Capital - Subscribed
capital is a subset of Issued share capital that represents the number of
shares purchased by the general public. It is never required that all
issued shares be purchased by the general public.
What Is Backstop?
There are various ways for a business to raise the necessary funds. Going public is one of them. When a corporation issues open-market shares to raise capital, there is no certainty that the shares will be completely subscribed. In the event of insufficient funds, the backstop ensures financial provisions. A "backstop" is defined as something that supports or reinforces something. In the stock market, a backstop is a financial arrangement that necessitates the establishment of a secondary source of finance if the original source of funds is insufficient to satisfy current needs. It is the last line of defence for finance seekers.
The backstop provider assumes the risk, reducing the uncertainty of financial requirements. It is comparable to an insurance policy in that it covers the requirement for a limited source of funds. It can be seen in several settings depending on its application. The backstop is critical in the company's day-to-day financial management. It is a short-term financing facility that allows the borrower to borrow a specific amount up to a certain limit for a set period of time, use it, and repay it. For example, ABC Company confronts a Rs 10,00,000 deficiency in 2021-22. The backstop facility can be used as a supplemental source of finance for the company to borrow Rs 1,00,000 and pay its obligations for the year. Following that, the corporation must repay it within the time frame specified.
Backstop in the stock market is primarily used for underwriting the issuance of shares. In this instance, the underwriter acts as a backup by guaranteeing the purchase of the unsubscribed component of the share offering. For providing the guarantee, certain fees are payable as a proportion of the entire issue size. Assume XYZ firms want to raise Rs 5,00,000 from the general public. It issues 5,000 Rs 100 shares each. For the backup, it entered into a deal with ABC, an investment bank. ABC promises to buy an unsubscribed portion of the share. XYZ raised Rs 4,00,000 from the open market by selling 4,000 shares. ABC will provide the remaining Rs 1,00,000 in exchange for 1,000 shares.
Importance Of Backstop
In addition to the risk, the backstop providers own shares. The issuer corporation no longer owns any of those shares. This means they no longer have the power to further treat the shares or set any restrictions on them. If all of the offers are purchased by open market investors and other investment vehicles, the contract between the issuer and the backstop provider becomes null and unenforceable because the condition of the pledge to purchase unsubscribed shares no longer exists.
To summarise, a backstop is a support
mechanism that enables fund searchers to raise the desired quantity of funds
without encountering any obstacles. When utilized in underwriting, the firm is
guaranteed complete subscription regardless of open market activity.