When a firm goes public in the equity market, it typically engages an investment bank (underwriter) to oversee the valuation, marketing, and legal aspects of the offering. Moreover, in a firm commitment (underwritten) offering the investment bank guarantees the sale of a specified number of shares at a designated offer price, thereby guaranteeing the issuing firm a set level of proceeds.
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| Gross Spread |
As such, the risk of sale is transferred from the issuer to the underwriter. In exchange for this guarantee, and as compensation for other services performed, the underwriter charges a gross spread on the offering.
The gross spread is specified as a percentage of the proceeds from the offering. For the majority of standard-sized equity issues, the gross spread is relatively fixed at the 7% level. For the smallest offerings, primarily penny stock issues, the risk is higher, and therefore, spreads tend to be larger.
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Most of these issue types face a gross spread of 10%. For larger offerings, economies of scale and reduced pricing risk typically result in lower gross spreads, likely in the 4–5% range.
Gross spreads are not specific to equity issues, but are generally applied in any situation where the investment bank is underwriting a security issue. The other common occurrence, therefore, deals with the public issuance of debt.
In such cases, the gross spread percentage is much smaller (typically around 2%, on average), as there is less pricing risk associated with debt issues relative to equity issues.
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