Best Efforts

What Are Best Efforts?

The term best efforts refers to an agreement made by a service provider to do whatever it takes to fulfill the requirements of a contract. In finance, an underwriter makes a best efforts or good faith promise to the issuer to sell as much of their securities offering as possible. While the two parties come to an agreement for the sale of some securities, the underwriter doesn't guarantee to sell them all.

Understanding Best Efforts

When a company decides to sell securities, it enlists the help of an investment bank to execute the sale. This is common during initial public offerings (IPOs). Both parties draw up a best efforts agreement that outlines the minimum amount of securities involved. Having an agreement lets securities issuers know exactly how much money they will raise once the offering is closed. In most cases, best effort agreements are used in less-than-ideal market conditions or when there is more risk involved, as is the case with an unseasoned offering.

Investment banks have the option to purchase enough shares to meet client demand under a best efforts agreement. The bank may also act as an underwriter or agent to arrange the public offering and sell the stock issue to the public. In this case, the underwriter agrees to sell a certain number of shares to investors and get the best price possible for the issuer. Some banks choose to partner with others and form a syndicate to facilitate the offering.

Best efforts offerings sometimes contain conditions, such as all-or-none and part-or-none. All-or-none offerings require the entire offering to sell for the deal to close. With a part-or-none offering, only a set amount of securities qualify to close the deal.

A best-efforts agreement limits both the underwriter's risk and their potential for profit since they generally receive a flat fee for their services. Under the Financial Industry Regulatory Authority's (FINRA) SEA Rule 10b-9, investor funds must be returned promptly if contingency offerings are not realized.

Under FINRA regulations, investor funds must be returned promptly if contingency offerings are not realized.

Best Efforts vs. Firm Commitment

Underwriters and issuers can handle public offerings in different ways. In contrast to a best-efforts agreement, a bought deal, also known as a firm commitment, requires the underwriter to purchase the entire offering of shares. The underwriter's profit is based on how many shares or bonds it sells, and on the spread between their discounted purchase price and the price at which they sold the shares.

Best Efforts Example

In September 2015, Aperion Biologics filed an offering statement on Form 1-A with the Securities and Exchange Commission (SEC) to sell $20 million in an IPO. The agent, WR Hambrecht+ Co., employed a best efforts approach to selling the Aperion shares.

As defined in the Jumpstart Our Business Startups Act (JOBS), Aperion is a small company that qualifies as an emerging growth company. For the fiscal year ending Sept. 30, 2015, revenue was $34,000. Considering Aperion's small size, WR Hambrecht chose to underwrite a best-efforts offering to minimize its risk by not selling the shares.

The January 2016 filing registered 3.1 million Aperion shares, and the proposed price range of $7 to $9, with the shares offered on an all-or-none basis.