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Market Out Clause What It Is How It Works

Market Out Clause What It Is How It Works

Market Out Clause: What It Is, How It Works

What Is a Market Out Clause?

A market out clause is a provision in an underwriting agreement that allows the underwriter to cancel the agreement without penalty. It can be activated due to souring market conditions or difficulty in selling the company’s stock, among other reasons. However, the specific reasons must be included in the market out clause.

Key Takeaways:

– A market out clause allows an underwriter to cancel an agreement without penalty.

– It is typically used in a firm commitment underwriting, where the underwriter assumes all inventory risk and buys all securities for an IPO.

– The market out clause can be triggered by a change or decline in market conditions or to relieve the underwriter of holding stock that won’t sell.

– The clause must specify the conditions under which it can be enacted.

Understanding a Market Out Clause

A market out clause reduces an underwriter’s risks in a firm commitment underwriting. The underwriter contracts with the issuing company to market and sell its stock in the primary market. This type of underwriting involves assuming inventory risk and purchasing securities for an IPO directly from the issuer.

However, there are risks associated with this, such as overhype or declining market conditions. This is why market out clauses are often invoked during market downturns or underperforming IPOs.

A market out clause can also allow the underwriting syndicate to opt-out of the agreement before the IPO if certain conditions are met, such as a trading suspension or a material change that affects the issuer.

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When drafting an IPO underwriting agreement, the conditions for activating the market out clause must be carefully reviewed. A broad market out clause can undermine the concept of firm commitment underwriting and shift all the risks to the issuing company.

Sample Market Out Clause Language

Here’s a section from an underwriting agreement between Rackable Systems and its underwriters to sell 2.6 million shares of the company’s common stock.

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