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Most investors hardly see the backend process of purchasing stocks and other investments. Oftentimes, retail and newbie investors will go on their brokerage app or website and make stock and investment purchases according to their own research. There are always a certain number of shares that a company is willing to put up for sale. These shares can range depending on the current market price. However, for smaller companies, it can be risky to go public in the market if there’s uncertainty on whether or not all shares will be purchased by investors.

This is where a bought deal comes into play.

When a company decides to offer shares of their company to investors but want to avoid the risk of not being able to sell all of the shares, they will work with an investment bank or an underwriter to secure a firm commitment. An underwriter is a third-party that manages and assumes the risk of the company. When this risk is assumed by either the investment bank or the underwriter, this is a bought deal private placement. While a bought deal seems like an easy way for a company to gain more capital, the companies have to pay a fee to the third-party, as they are taking financial responsibility in case all of the shares are not sold in the market.

If Company A decides to offer 100 shares for $1 apiece at the market value, but figures that there’s a possibility that all shares might not be sold, they will sell all 100 shares to an investment bank for a discounted price. Instead of selling the full amount of shares for $100, Company A will give a heavy discount.

A bought deal is kind of like reselling your proclaimed precious (but no longer needed) items on eBay. You probably resell these items for a decent and discounted price just to get them off your hands and make a bit of quick cash. Chances are, if the items you’re selling are actually in good condition, the buyer may end up reselling the items themselves for more than you initially sold it for. Sure, you made an easy buck or two, but it’s the reseller who really ends up lucking out if they’re able to sell your items again.

How Investment Banks Make Money

When the investment bank releases the shares of Company A to the market, they (if they’re smart) should sell the shares in an IPO for more than the discounted price they purchased the shares from so that the investment bank doesn’t end up losing money.

A bought deal, however, is not a “get rich quick” scheme. Even though companies use bought deals to gain capital quickly they are still using money due to the fact that they have to sell the shares to an investment bank for a deep discount.

What is a Bought Deal Used For?

A bought deal is used by any company that is looking to raise capital quickly. A bought-deal allows companies to bypass an IPO and instead offer the shares to a bank to get money quickly.

In the United States, bought deals are not that common. In Canada, however, bought deals are popular and give companies an advantage by allowing them to quickly generate capital without waiting for each individual share to be sold.

What to Look For to Make Money

Unless you’re a venture capitalist or are working for an investment bank, a bought deal private placement won’t impact the average investing Joe too much. However, if you are either a venture capitalist or work for an investment bank, you should ensure that the company you’re purchasing the placement from is offering you a heavy discount. Remember, bought deal private placements are high-risk in the event that they’re unable to be sold.

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