Book building is a method used to discover the optimal price during an IPO. Companies define a price band, and investors place bids within this range. The final price is set based on demand, usually where the highest number of bids cluster. This helps gauge investor sentiment and determine a fair market-driven share price.
Book building is how underwriters determine the IPO share price. They collect bids from institutional investors, such as fund managers, to establish the optimal price. However, this process carries the risk of setting the price too high or too low, impacting investor interest and market perception. During this phase, investors submit bids indicating how much they want to buy and the price they're willing to pay, which influences the final pricing of the securities.
How does book building work?
Book building is a mechanism used during IPOs where investors bid within a specified price range. The issue price is finalised based on overall demand. This method offers efficient pricing, enhances market transparency, ensures better capital mobilisation, and allows fair distribution of shares among institutional and retail investors based on bidding interest:
- Partnering with the underwriter
Companies enlist investment banks as underwriters for their IPOs. These experts guide the company in setting the IPO's size (number of shares offered) and price range. - Bidding frenzy
The underwriter and the company invite investors to participate. Investors then submit bids for the IPO shares within the announced price range. - The price puzzle
The underwriter keeps a close eye on all bids, compiling them in an order book. This book serves as a roadmap to determine the most suitable IPO price using methods like the weighted average. - Allocation allure
Once the final IPO price is set, shares are allocated to investors whose bids were accepted. If you bid higher than the cut-off price, the extra amount you paid will be refunded.
Why do companies opt for the book-building process?
Indian companies opt for the book building process when determining the IPO share price for several compelling reasons:
- Market-driven pricing
The book building process allows the share price to be determined based on investor demand and market conditions rather than a fixed price set by the company. This ensures that the IPO price reflects the true market value of the shares, leading to a more accurate and fair valuation. - Investor confidence
The transparency and fairness of the book building process can boost investor confidence. Knowing that the price is market-driven and not arbitrarily set by the company, investors are more likely to participate. - Reduced underpricing
Fixed price offerings often lead to underpricing or overpricing, which can result in significant price volatility post-IPO. Book building tends to minimise these risks by aligning the issue price more closely with market demand, leading to more stable post-IPO performance. - Better allocation of shares
The process allows companies to allocate shares more efficiently among different types of investors. Institutional investors, who generally have better market insights and investment strategies, are more involved in the book building process, leading to a more balanced and strategic allocation of shares. - Regulatory support
The Securities and Exchange Board of India (SEBI) has laid down clear guidelines for the book building process, making it a well-regulated and structured method for pricing IPOs. This regulatory framework ensures the process is conducted fairly and transparently. - Market feedback
Companies receive valuable feedback from potential investors during the book building process. This feedback can provide insights into investor expectations and market sentiment, which can be crucial for the company’s future strategies and decision-making.
In summary, companies prefer the book building process for IPO pricing due to its market-driven approach, transparency, efficiency in capital raising, and ability to better align the share price with investor demand and market conditions.
Types of book building
Let us explore the types of book building:
Accelerated Book Building Method
The accelerated book building method allows a company to set a price band and invite bids from institutional investors over a very short duration. This quicker approach facilitates faster price discovery and is ideal when companies urgently need capital or wish to quickly enter the market. It significantly reduces the IPO timeline compared to the traditional book building method.
Partial Book Building Method
In the partial book building method, a company offers a portion of the shares through bidding while pricing the rest at a fixed rate. This allows for a mix of market-driven and controlled pricing. It’s beneficial for companies seeking a balance between demand-based pricing flexibility and predictability in raising funds through the book building method.
What is the book-building process in IPO?
The book-building process typically involves the following steps:
- Appointment of intermediaries
The issuer appoints lead managers or book runners to manage the book-building process. These intermediaries assist in determining the offer price, marketing the issue, and allocating securities. - Filing of draft offer document
The issuer files a draft offer document with the regulatory authority, providing details about the company, its operations, financial performance, and the proposed offering. - Marketing and roadshows
The lead managers conduct marketing activities and roadshows to generate investor interest and educate potential investors about the offering. - Bidding period
The issuer specifies a bidding period during which investors submit bids for the securities, indicating the quantity they wish to purchase and the price they are willing to pay. - Price discovery
Based on the bids received, the lead managers assess investor demand and determine the final offer price within the price band specified in the offer document. - Allocation of securities
Once the offer price is finalised, securities are allocated to investors based on their bids, with preference given to institutional investors and high-net-worth individuals. - Listing and trading
Upon completion of the allotment process, the securities are listed on the stock exchange, allowing investors to trade them in the secondary market.
Advantages of book building
Book building offers several advantages over traditional fixed-price offerings:
- Efficient price discovery: Enables fair valuation through market-driven pricing based on demand.
- Greater transparency: Offers real-time visibility of investor interest, reducing pricing uncertainty.
- Optimised capital raising: Helps companies raise maximum funds by identifying the ideal price point.
- Fair share allocation: Ensures balanced distribution among different investor classes.
- Minimises mispricing: Reduces the chances of underpricing or overpricing, benefiting both issuers and investors.
Additional read: Difference between FIIs and DIIs
Disadvantages of book building
While book building offers advantages such as price discovery and flexibility, it also presents several challenges and disadvantages as follows:
- More suitable for high-value public issues, especially where companies are targeting institutional investors or HNIs.
- Smaller companies may prefer private placements or fixed-price offerings for ease and certainty.
- Retail investor participation may be limited, as not all meet the eligibility criteria for bidding in a book building issue.
- Retail investors can still apply once the cut-off price is disclosed, especially in partial issues.
- Some book building methods, such as accelerated issues, may only be open to select investor groups like HNIs, UHNIs, and institutions.
- The underwriting process in a book building issue is generally more intricate than that in a fixed-price offering.
Difference between fixed-pricing and book-building
Below is a comparison between fixed-pricing and book-building mechanisms:
Fixed-pricing |
Book building |
The offer price is predetermined by the issuer |
The offer price is determined based on investor demand |
Limited scope for price discovery |
Facilitates price discovery through investor bidding |
Fixed allocation of securities |
Securities allocated based on investor bids |
Less flexibility in adjusting pricing |
Offers flexibility to adjust pricing within a price band |
May result in underpricing or overpricing |
Helps mitigate pricing risks through market participation |
Conclusion
In conclusion, book building has become a preferred method for pricing IPOs in the Indian securities market due to its ability to facilitate price discovery, enhance investor participation, and accommodate market dynamics. By allowing issuers to gauge investor demand and set offer prices competitively, book building contributes to efficient capital allocation and market transparency. However, it is essential for market participants to carefully assess pricing risks and ensure that offerings are priced appropriately to mitigate adverse outcomes. As the Indian securities market continues to evolve, book building is expected to remain a prominent feature, shaping the landscape of capital raising and investment activities.
