Eating Stock

Eating stock refers to the forced purchase of a security when there are insufficient buyers. The term generally applies to underwriters of a company’s initial public offering (IPO). However, it also happens when stockbrokers needs to sell shares of a stock that is performing poorly and they are unable to find buyers.

When a company goes public, it requires a certain number of subscribers, or people to purchase shares of the stock. When there aren't enough subscribers to cover the IPO, the underwriter generally steps in to purchase the remaining shares. This is when the underwriter is said to be eating stock.

Sometimes, underwriters have a legal obligation to buy the stock in order to push the IPO through. This can initially put them at a loss despite their underwriting fee.

Eating stock is an action on the part of the underwriter that allows the company going public to have a better approximation for the amount of capital it will raise from the offering. It also helps ensure that the company is able to cover the cost of any capital expenses associated with the IPO, which some analysts think makes it more likely that the stock will do well in the future.

If a company opts to go public and sell shares, it needs an underwriter. The investment bank serving as the company’s underwriter receives a substantial fee for this service from the company. This fee is how underwriters mitigates their own risk. In exchange, the underwriter pays off stockholders who sell their shares in the event the company itself is not in a position to do so at the time. Eating stock does not mean that the underwriter takes a loss on the entire venture. That won't be the case if the underwriting fee exceeds the cost of the absorbed shares.

Say a company decides to go public with an IPO of 1,000 shares, and the firm doesn't have a great reputation and isn't known by many investors Underwriters try to drum up interest. At the close of the offering, 100 shares remain unsold. In order to fully fund the IPO, the underwriter buys those shares. In the eventthe stock does well the underwriter benefits. Otherwise, the purchase results in a loss.