The gross spread—also known as the underwriting spread—represents the compensation that underwriters receive for facilitating the issuance of new securities. It is calculated as the difference between the price at which underwriters purchase shares from the issuing company and the price at which they sell these shares to the public.

Components of the Gross Spread:

The gross spread typically comprises three main components:

1. Management Fee: This fee compensates the lead underwriter or manager for coordinating the IPO process.
2. Underwriting Fee: Earned by the underwriting syndicate members, this fee covers the risk they assume by purchasing the securities from the issuer.
3. Selling Concession: This is allocated to broker-dealers responsible for selling the shares to investors.

The distribution of these components can vary, but a common allocation is 20% to the management fee, 20% to the underwriting fee, and 60% to the selling concession.

Factors Influencing the Gross Spread:

Several factors can affect the size of the gross spread, including:

• Size of the Offering: Larger offerings may have a lower percentage gross spread due to economies of scale.
• Perceived Risk: Higher-risk offerings may command a larger gross spread to compensate underwriters for the increased risk.
• Market Conditions: Prevailing market volatility and investor demand can influence the gross spread.

Typical Gross Spread Percentages:

In the U.S. IPO market, gross spreads often range from 6% to 8% of the offering price. However, for large offerings, such as Alibaba's IPO, the gross spread can be as low as 1.2%, which still amounted to $261 million due to the offering's substantial size.

Example Calculation:

Consider a company that sells shares to underwriters at $36 per share, and the underwriters then sell these shares to the public at $38 per share. The gross spread in this scenario is $2 per share, equating to approximately 5.3% of the offering price.

Significance of the Gross Spread:

The gross spread is crucial as it compensates underwriters for their services, including:

• Assuming Risk: Underwriters purchase the entire offering from the issuer, assuming the risk of selling the shares to the public.
• Marketing the Offering: They are responsible for generating investor interest and ensuring the successful sale of the securities.
• Covering Expenses: The spread also covers various expenses, such as legal, accounting, and regulatory filing fees.

Understanding the gross spread provides insight into the costs associated with going public and the financial incentives for underwriters in the IPO process.