What Is Selling Concession?
A selling concession is a fee paid to a broker-dealer or selling group member for successfully selling a portion of a new securities issue to investors. It is a critical component of the compensation structure within capital markets offerings, particularly in the realm of investment bank underwriting. This fee incentivizes individual firms to distribute new stocks or bonds to their clients, ensuring a broad placement of the securities. The selling concession is distinct from other fees, representing the portion of the overall underwriting compensation allocated specifically for sales efforts.
History and Origin
The concept of compensating intermediaries for distributing securities dates back to the early days of financial markets. As the complexity and scale of securities offerings grew, particularly with the rise of modern investment banking, formal structures for compensation emerged. The practice of a selling concession became a standardized part of underwriting agreements to ensure efficient distribution of newly issued shares or bonds. This evolution reflects the need to incentivize a broad network of firms to reach both retail investors and institutional buyers. Over time, regulatory bodies, such as the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC), have established rules governing these concessions to ensure fairness and transparency in the distribution process.7
Key Takeaways
- A selling concession is the compensation paid to a broker-dealer for selling new securities in a public offering.
- It is a component of the total gross spread charged by underwriters to the issuer.
- The fee incentivizes selling group members to actively market and distribute the new issue.
- Regulatory bodies like FINRA impose rules on how selling concessions can be granted and received.6
- The amount of the selling concession is typically disclosed in the offering documents.
Formula and Calculation
The selling concession is a component of the gross spread, which is the difference between the price at which the underwriter buys the securities from the issuer and the public offering price at which they are sold to investors. The gross spread typically consists of three parts:
- Management Fee: Compensation for the lead underwriter's origination, structuring, and syndication efforts.
- Underwriting Fee (or Risk Takedown): Compensation for the underwriter's risk in committing to purchase the securities from the issuer.
- Selling Concession: Compensation for the actual sale of the securities to investors.
The formula for the total gross spread is:
The selling concession is typically expressed as a percentage of the public offering price per security. For example, if a bond is offered at $1,000 and the selling concession is 0.5%, the concession per bond is $5. The issuer ultimately bears the cost of these fees, as they reduce the net proceeds received from the offering.
Interpreting the Selling Concession
The size of a selling concession can vary depending on several factors, including the type of security, the size and complexity of the offering, market conditions, and the perceived demand for the issue. For instance, a higher selling concession might be offered for a more challenging offering or one that requires significant sales effort to attract retail investor participation. Conversely, highly anticipated issues with strong demand may feature lower concessions, as less incentive is needed to sell them.
For investors, the selling concession is typically included within the public offering price and not charged as an explicit fee at the point of sale. Broker-dealers receive this compensation for facilitating the purchase of newly issued securities by their clients, which means it impacts the overall cost structure for the issuer.
Hypothetical Example
Imagine TechInnovate Inc. is conducting an initial public offering (IPO) of 10 million shares at an offering price of $20 per share. The lead underwriter forms a syndicate of various broker-dealers to help distribute the shares.
The total gross spread for this IPO is set at $1.20 per share, meaning the issuer receives $18.80 per share. This $1.20 is broken down as follows:
- Management Fee: $0.20 per share
- Underwriting Fee: $0.30 per share
- Selling Concession: $0.70 per share
A selling group member, "XYZ Brokerage," successfully sells 100,000 shares of TechInnovate Inc. stock to its clients. For these sales, XYZ Brokerage will earn a selling concession of $0.70 per share.
Total selling concession earned by XYZ Brokerage = (100,000 \text{ shares} \times $0.70/\text{share} = $70,000).
This $70,000 is their compensation for the sales effort, illustrating how the selling concession directly rewards firms for their role in the distribution process.
Practical Applications
Selling concessions are primarily applied in the primary market for newly issued securities, such as during an initial public offering (IPO), secondary offering, or bond issuance. They are a standard part of the economics of a fixed price offering where an underwriter or syndicate commits to purchasing the securities from the issuer and then reselling them to the public. The selling concession ensures that all firms involved in the sales process are appropriately compensated for their efforts in reaching investors.
Regulatory bodies like FINRA have specific rules, such as FINRA Rule 2740, which governs how selling concessions can be granted and received, limiting them to registered broker-dealers engaged in the securities business.5 This regulatory oversight aims to prevent improper payments and maintain integrity in the distribution process. The SEC also plays a role in overseeing the disclosure of such fees to ensure transparency for investors and issuers, as detailed in its guidance on how securities are offered.4
Limitations and Criticisms
While essential for incentivizing distribution, selling concessions and the broader underwriting spread have faced scrutiny. A common criticism, particularly in the context of initial public offerings (IPOs), is the perceived lack of transparency and rigidity in fees. Some argue that the standard fees, including the selling concession component, can be substantial and may not always reflect the actual effort or risk involved, especially in highly sought-after deals.3 Concerns have been raised that the total cost of bringing a company public, heavily influenced by these fees, can be a significant "IPO tax" for issuers, potentially deterring smaller companies from accessing public markets.2
Another critique revolves around the allocation of the overall gross spread among the various parties in an underwriting syndicate. Disputes can arise regarding the balance between the "work fee" (for lead managers' due diligence and structuring) and the sales-based components like the selling concession, with some arguing that sales efforts are not adequately rewarded compared to upfront advisory work.1
Selling Concession vs. Underwriting Spread
While often used interchangeably by the public, "selling concession" and "underwriting spread" refer to different, though related, financial concepts within capital markets.
The selling concession is a specific portion of the compensation paid to a broker-dealer for actively selling a new issue of securities to investors. It is the commission earned by the selling group member for each unit (share or bond) they successfully place with a buyer. Its purpose is to incentivize the direct sales effort.
The underwriting spread, also known as the gross spread, is the total difference between the price an issuer receives for its securities and the public offering price paid by investors. It is the comprehensive fee charged by the entire underwriter syndicate for managing, underwriting the risk, and distributing the securities. The underwriting spread comprises three main components: the management fee, the underwriting fee (or risk premium), and the selling concession. Thus, the selling concession is a part of the broader underwriting spread, representing the sales-specific component.
FAQs
What is the primary purpose of a selling concession?
The primary purpose of a selling concession is to incentivize broker-dealers and members of the selling group to actively market and sell new securities to their client base. It ensures that firms are compensated for their efforts in distributing the offering broadly.
Who pays the selling concession?
While the broker-dealer who sells the security receives the selling concession, the cost is ultimately borne by the issuer of the securities. It is factored into the total gross spread deducted from the public offering price before the issuer receives the net proceeds.
Is the selling concession negotiable?
The total underwriting spread, of which the selling concession is a part, can be negotiable, especially for larger or highly sought-after offerings. Factors like the size of the offering, the issuer's reputation, and market demand can influence the fees. However, the internal allocation of the spread, including the selling concession, is typically determined by the lead underwriter for the syndicate.