Backstop Purchaser

A backstop purchaser is an entity that agrees to purchase all the remaining, unsubscribed securities from a rights offering, or issue. In this case, the rights offering is set up beforehand by the issuer as an insured rights offering. The backstop purchaser provides security to the issuing firm by guaranteeing that all of the newly issued shares will be purchased, allowing the company to fulfill its fundraising requirements. A backstop is also known as a standby purchaser.

Backstop purchasers are one form of standby underwriting, where one or more investment banks enter into an agreement with the company in which they agree to publicly sell any unsubscribed shares for a price generally no less than the subscription price associated with the rights offering. In the case of backstop or standby purchasers, the party agrees to go further and buy the unsubscribed shares. Backstop purchasers are usually called on after other underwriting parties have failed to sell all of the shares at a discount to the public.

The New York Stock Exchange (NYSE) generally views rights offerings as public offering for cash and are not subject to shareholder approval. Yet insured rights offerings differ: their additional fundraising rounds are subject to scrutiny.

The backstop purchase generally comes after three preceding rounds of rights offering. In the first round, the company offers existing shareholders the opportunity to purchase shares the stock at a discount to the market price. In the second round, the company offers existing shareholders the right to subscribe for additional shares that remain unsubscribed. In the third round, the company enters into an underwritten agreement where one or more underwriters have agreed to purchase any shares not taken up in the rights offering, including in the oversubscription, for resale to the public in an underwritten offering. The NYSE views this round as a public offering for cash only if marketing efforts are made to a large group of potential purchasers and if shares are purchased by a least some of these potential buyers. In the fourth round, backstop purchasers may buy up to 19.9% in the aggregate of the shares of common stock prior to the rights offering.

Backstop purchasers may face constraints if they are related parties: directors, officers, 5% shareholders, or any person or company affiliated with those position-holders. There is no broker‐dealer licensing requirement for backstop purchasers, but most do have such a license as they are generally investment banks or underwriting syndicates. In the case that one or more substantial investors agree to act as a backstop purchaser, they are not allowed to engage in activities to mitigate the risk of an under‐subscription and they will not receive a standby fee. Furthermore, if the related party wants to participate in other rounds of the offering, they must sit out one of the rounds. Finally, the related party must buy the shares in the standby purchase on the same terms offered to existing shareholders in the rights offering.

An issuer might consider a standby offering and backstop purchaser if they are required to raise a specific amount of capital. Yet when calculating the number of share sales necessary to raise the required capital, an issuer should factor backstop fees into the offering amount: backstopping can cost companies large fees as the backstop purchaser takes on the risk of issuing new securities and is paid a premium in return. For example, in 2006, when Warren Buffet's Berkshire Hathaway acted as a backstop purchaser for the USG Corporation, it earned a non-refundable fee of $67 million for the service. Backstop compensation is generally a flat standby fee plus a per-share amount. 

An issuer might also consider a standby rights offering if the stock price is volatile. Because the offering period is anywhere from 16 to 45 days, shareholders can afford to wait until the end of the period to decide whether they will exercise their rights and subscribe based on the price of those shares trading in the market, which could be the same or less than subscription price. The issuer doesn't want to set the subscription price too low but must consider the possibility that shareholders will balk. A backstop purchaser is an attractive mitigating force in this event.