How does an investment bank make money as the underwriter of an IPO?

Answer 1

The managing underwriters (The investment banks) may underwrite the IPO on either a firm commitment or best efforts basis. In a firm commitment offering, the underwriters will purchase the shares at a discount (of usually 7%) and resell them for the full public offering price to institutional and individual investors. In contrast, a best efforts offering means that the underwriters are only committing their best efforts to sell the shares. Most reputable investment banks will underwrite an IPO on a firm commitment basis. If an IPO is being underwritten on a best efforts basis, it should serve as a warning signal to both the company and its potential investors. After all, how enticing will a company's shares appear if its investment bank is unwilling to shoulder the risk of holding the shares, especially when purchased at a discount?

To help distribute the shares, the managing underwriters may form a syndicate composed of other investment banks. This serves two purposes. First, the underwriters may expand the marketing of the company's shares through other investment banks. Second, the managing underwriters may reduce their risks by allocating shares to other investment banks. The syndicate members may agree to participate by either purchasing and reselling the shares, or just marketing the shares to their institutional and individual clients.

This 7% is how, investment banks make money during an IPO process...