📚 PASS Research Analyst Certification Examination Difficulty: Beginner ℹ️ Info   ~5 min read
📌 Chapter 2.4 — Various Market Participants and Their Activities

Imagine you are reviewing a Red Herring Prospectus (RHP) for a high-growth technology firm planning its IPO. As an analyst, you notice the issue is structured with both ‘underwritten’ and ‘best effort’ components. Understanding the distinction between these underwriting types is critical because it signals the investment bank’s confidence level in the issue’s market reception and fundamentally alters the liquidity risk profile of the stock you are about to model.

In a ‘hard’ underwriting arrangement, also known as a firm commitment, the underwriter essentially acts as a principal. They agree to purchase the entire unsubscribed portion of the issue at a predetermined price, effectively guaranteeing the issuer receives the full capital requirement regardless of retail or institutional demand. For your valuation model, this provides a buffer; the underwriter is literally putting their own balance sheet at risk, which generally indicates a highly vetted, high-conviction offering.

Conversely, a ‘soft’ underwriting or ‘best effort’ arrangement involves the merchant banker acting as an agent rather than a principal. They promise to use their best efforts to sell the securities to the public, but they assume no financial liability for unsold portions. If the market appetite for the IPO is lukewarm, the issue might fail to fully subscribe, potentially leading to a significantly lower liquidity floor than your DCF model might have initially assumed.

Consider a case where an infrastructure company requires massive capital to reach operational break-even. If the issue is underwritten via a hard commitment, you can be more certain about the capital inflow and project commencement. However, in a best-effort scenario, the risk of capital shortfall is significantly higher, which should prompt you to adjust your risk-weighted cost of capital upward to account for the heightened execution risk during the listing phase.

Distinguishing these roles ensures your research does not overlook the potential for a ‘deal collapse’ that could render your growth assumptions obsolete. 1

Nuance

⚠️ Nuance
Candidates often confuse ‘soft underwriting’ with a lack of professional responsibility, assuming the merchant banker simply ‘gives up’ if demand is low. In reality, a best-effort arrangement is a sophisticated contractual strategy often used in volatile sectors where the risk of loss is too high for a lead manager to back with their own capital. Analysts must realize that the absence of a hard commitment is not necessarily a reflection of the company’s quality, but rather an indicator of the underwriter’s risk appetite relative to market conditions.

Check Your Understanding

Practice Question 1

An analyst is evaluating the risk profile of an IPO for a mid-cap manufacturing firm. The prospectus states the merchant banker has entered into a ‘Firm Commitment’ agreement for the entire issue. What is the primary implication of this for the analyst?

Practice Question 2

Which of the following best describes the ‘Best Effort’ underwriting arrangement?

This is a companion read for Section 2.4 — Various Market Participants and Their Activities from PASS Research Analyst Certification Examination by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.

  1. In the Indian context, SEBI regulations stipulate that if an issuer does not receive 90% of the subscription of the fresh issue, the application money must be refunded. This threshold makes the distinction between firm commitments and best efforts a vital component of assessing the IPO’s ‘go-to-market’ success probability. ↩︎