What is Book Building Process in IPO? Fixed Pricing Vs Book Building

Companies have two methods to determine IPO prices: Fixed pricing and the book-building method. In the fixed rate approach, the company decides the share prices for the public offering in advance. On the other hand, the book-building method presents a different scenario.

In this guide, we will explore what book-building entails, understand its procedure, identify its types, and uncover the significant distinctions between these two pricing techniques, among other essential details.

What is IPO Book Building?

IPO Book Building is a method used by companies to determine the price at which their shares will be offered to the public.

Unlike traditional fixed-price offerings, where the price is predetermined, book building allows for a price discovery mechanism. Investors express their interest in buying shares within a price range, contributing to the formation of a ‘book’ that reflects the demand at various price levels.

Also Read : 11 Common mistakes to be avoided while investing in an IPO

IPO Book Building Process

The book-building process is a dynamic and market-driven method that companies use to determine the price at which they will issue their shares during an forthcoming Initial Public Offering. Below is a detailed overview of the key steps involved in the book-building process:

1. Appointment of Book Running Lead Managers (BRLMs):
   • The company planning to go public appoints BRLMs, which are typically financial institutions with expertise in managing IPOs.
   • BRLMs play a crucial role in coordinating and facilitating the book-building process.
2. Drafting the Prospectus:
   • A comprehensive document known as the prospectus is drafted and filed with the market regulator (e.g., Securities and Exchange Board of India – SEBI).
   • The prospectus contains essential information about the company, its financials, and the proposed IPO.
3. Price Band Determination:
   • The issuer, in consultation with the BRLMs, sets a price band within which investors can bid for shares.
   • The price band consists of a floor price (minimum bid) and a cap price (maximum bid).
4. Building the Book:
   • The IPO is open for a specific period during which investors, especially institutional investors, submit their bids.
   • Investors can bid for shares at a price within the predetermined price band.
5. Bidding Process:
   • Institutional investors, including mutual funds, insurance companies, and foreign institutional investors (FIIs), submit their bids stating the quantity of shares they want and the price they are willing to pay.
   • The bidding process allows for competitive price discovery.
6. Retail Investor Participation:
   • In addition to institutional investors, retail investors can also participate in the book-building process.
   • Retail investors typically bid at the cut-off price, and their allotment is made at the final discovered price.
7. Price Discovery:
   • The final issue price is determined based on the bids received during the book-building period.
   • The price is often set at the level where the demand is the highest, ensuring optimal price discovery.
8. Allotment and Refund:
   • Once the price is determined, shares are allotted to investors.
   • In case of oversubscription, allotment is done proportionally, and the excess application money is refunded.
9. Listing on Stock Exchange:
   • After the allotment, the company’s shares are listed on the stock exchange for public trading.
   • Investors who were allotted shares can sell them on the secondary market.
10. Post-IPO Activities:
    • The company enters the post-IPO phase with increased capital, which it can use for business expansion, debt repayment, or other corporate purposes.
    • Continuous disclosure and compliance with stock exchange regulations become crucial for the newly public company.

Difference between Fixed-Pricing and Book Building

The difference between fixed pricing and book building lies in how the issue price of shares is determined during an Initial Public Offering.

Fixed Pricing:

1. Predetermined Price:

• Characteristic: In fixed pricing, the issuing company decides on a specific price at which its shares will be offered to the public.
• Example: If a company determines that the fixed price for its IPO is ₹20 per share, all investors, both institutional and retail, will purchase the shares at this predetermined price.

2. Lack of Investor Involvement in Pricing:

• Characteristic: Investors do not have the opportunity to influence or bid for the price of the shares.
• Example: All investors who subscribe to the IPO during the fixed pricing period will receive shares at the same predetermined price.

3. Limited Flexibility:

• Characteristic: The fixed pricing method lacks the flexibility of adjusting the share price based on market demand.
• Example: If market conditions change between the announcement of the IPO and the actual offering, the company cannot react by adjusting the share price.

Book Building:

1. Dynamic Price Discovery:

• Characteristic: Book building is a dynamic process where the issuing company and lead managers determine a price band within which investors can bid for shares. The final price is then determined based on investor demand.
• Example: A company might set a price band of ₹18 to ₹20 per share, and investors can submit bids within this range.

2. Investor Involvement in Pricing:

• Characteristic: Investors, especially institutional ones, actively participate by submitting bids at the price they are willing to pay for the shares.
• Example: Institutional investors might bid ₹19 per share, expressing their willingness to buy at that price.

3. Market-Driven Flexibility:

• Characteristic: The final issue price is determined based on the bids received during the book-building period, allowing for market-driven flexibility.
• Example: If the demand for shares is high at ₹19, the final issue price might be set at that level.

Comparison:

• Pricing Mechanism:
  • Fixed Pricing: Shares are offered at a predetermined price.
  • Book Building: Shares are offered within a price band, and the final price is determined based on investor demand.
• Investor Involvement:
  • Fixed Pricing: Investors do not actively participate in determining the share price.
  • Book Building: Investors, especially institutional ones, play a crucial role in the price discovery process.
• Flexibility:
  • Fixed Pricing: Limited flexibility as the price is set in advance.
  • Book Building: Flexible pricing based on market demand, allowing for optimal price discovery.

Pros and Cons of Book Building Process in IPO

The book-building process in an IPO introduces a dynamic and market-driven approach to determining the issue price of shares. While it offers several advantages, there are also challenges associated with this method. Here’s a breakdown of the pros and cons:

Pros:

1. Market-Driven Pricing:
   • Pro: Market-driven price discovery allows for a more accurate reflection of investor demand and valuation.
   • Explanation: The book-building process considers bids from investors, resulting in a final price that aligns with market sentiment and demand.
2. Optimal Pricing:
   • Pro: Companies can avoid the risk of underpricing or overpricing their shares.
   • Explanation: By involving investors in the pricing process, the final issue price is more likely to be in line with the actual market demand, minimizing the chances of undervaluation or overvaluation.
3. Flexibility:
   • Pro: The method provides flexibility to adjust the price range based on changing market conditions.
   • Explanation: Companies can respond to market dynamics during the IPO process, optimizing the pricing strategy to maximize investor interest.
4. Increased Investor Participation:
   • Pro: Institutional and retail investors actively participate in the bidding process.
   • Explanation: Investors feel more engaged and have a say in the pricing, leading to increased participation and potentially broader investor interest.
5. Efficient Capital Raising:
   • Pro: Efficient capital raising is possible with a better alignment of the issue price with actual market demand.
   • Explanation: The likelihood of oversubscription and successful IPOs is higher, contributing to efficient capital mobilization for the issuing company.

Cons:

1. Complexity:
   • Con: The book-building process is more intricate compared to fixed pricing.
   • Explanation: The complexity can be a barrier for some investors and may require a higher level of understanding from both issuers and investors.
2. Volatility Risk:
   • Con: Market volatility during the book-building period may lead to uncertainties in pricing.
   • Explanation: Fluctuations in market conditions can affect investor sentiment, potentially impacting the final determined price.
3. Limited Price Certainty:
   • Con: Lack of certainty in the final price until the end of the book-building period.
   • Explanation: Investors may face uncertainty until the final price is established, which could influence their decision to participate.
4. Time-Consuming:
   • Con: The book-building process may take more time than fixed pricing.
   • Explanation: The need for investor participation, multiple rounds of bidding, and price discovery can extend the timeline of the IPO, affecting the speed of capital mobilization.
5. Potential for Manipulation:
   • Con: There’s a risk of manipulation, especially in cases where there’s insufficient regulatory oversight.
   • Explanation: Unscrupulous practices, if not adequately monitored, could impact the integrity of the book-building process.

Why do companies opt for the book-building process?

The decision for companies to opt for the book-building process in an Initial Public Offering is influenced by various strategic considerations. This market-driven pricing method offers several advantages that align with the goals and preferences of companies seeking to go public. Here are key reasons why companies choose the book-building process:

1. Market-Driven Pricing:

• Reason: Companies opt for book building to determine the issue price through a market-driven process.
• Explanation: This method allows companies to gauge investor sentiment and demand, ensuring that the IPO shares are priced in a way that reflects the actual market conditions.

2. Optimal Pricing:

• Reason: Book building helps companies avoid the risk of underpricing or overpricing their shares.
• Explanation: By involving investors in the pricing process, companies aim to achieve a fair valuation that maximizes investor interest while ensuring the company receives adequate funds for its expansion or other corporate purposes.

3. Flexibility in Pricing:

• Reason: The book-building process provides flexibility in adjusting the price range based on market conditions.
• Explanation: Companies can respond to changing market dynamics, optimizing the pricing strategy during the IPO period. This adaptability is particularly beneficial when market conditions are variable.

4. Increased Investor Participation:

• Reason: Companies seek active participation from a broad range of investors, both institutional and retail.
• Explanation: The book-building process engages investors in the pricing mechanism, fostering a sense of involvement. This increased participation can contribute to a more successful and oversubscribed IPO.

5. Efficient Capital Raising:

• Reason: The book-building process is associated with efficient capital mobilization.
• Explanation: With the potential for optimal pricing and higher investor participation, companies can raise capital more efficiently, maximizing the funds raised during the IPO.

6. Reduced Underpricing Risk:

• Reason: Book building helps mitigate the risk of underpricing shares.
• Explanation: By allowing the market to determine the price, companies aim to align their valuation with investor expectations, reducing the likelihood of leaving money on the table.

7. Competitive Positioning:

• Reason: Companies may choose book building for competitive positioning in the market.
• Explanation: By adopting a method that involves market dynamics, companies signal transparency and a commitment to fair pricing, potentially attracting a larger investor base.

8. Regulatory Compliance:

• Reason: The book-building process aligns with regulatory requirements.
• Explanation: Companies adhere to the guidelines set by market regulators, such as the Securities and Exchange Board of India (SEBI), which may encourage or mandate the use of book building for certain IPOs.

Types of Book Building

1. 100% Book Building:

• Characteristics:
  • The entire issue price is determined through the book-building process.
  • Investors, both institutional and retail, participate in the bidding to determine the final issue price.
• Application:
  • This type is widely used, especially in larger IPOs where a broader range of investors’ inputs is desirable.

2. Partial Book Building:

• Characteristics:
  • Only a portion of the issue price is determined through the book-building process.
  • The remaining portion follows a fixed pricing method.
• Application:
  • Companies might opt for partial book building to maintain some pricing certainty while still benefiting from market-driven pricing for a portion of the shares.

3. Fixed Price with 10% Price Band:

• Characteristics:
  • The majority of the issue price is fixed.
  • A small percentage, typically around 10%, is kept as a price band determined through the book-building process.
• Application:
  • This type strikes a balance between fixed pricing and market-driven pricing, allowing for some flexibility in the price range.

4. Fixed Price Followed by Book Building:

• Characteristics:
  • The IPO starts with a fixed pricing period.
  • If the issue is undersubscribed during the fixed pricing period, the remaining portion is determined through the book-building process.
• Application:
  • Companies might use this approach to gauge investor interest with a fixed price initially and then turn to book building if necessary.

5. Voluntary Book Building:

• Characteristics:
  • The book-building process is optional, and companies can choose whether or not to use it.
  • If the company opts for book building, a portion of the issue price is determined through this process.
• Application:
  • This type provides flexibility, allowing companies to assess market conditions and investor interest before deciding whether to use the book-building mechanism.

6. Mandatory Book Building:

• Characteristics:
  • Companies are required to use the book-building process for a specified portion of the issue price.
  • This is mandated by regulatory authorities.
• Application:
  • Regulatory bodies may prescribe mandatory book building for certain categories of issuers or in specific market conditions.

7. Extended Book Building:

• Characteristics:
  • The book-building period is extended beyond the typical duration.
  • This extension provides additional time for investors to submit bids.
• Application:
  • Companies might choose extended book building to accommodate a broader range of investor participation, especially in situations where initial interest is high.

Also Read : 7 Biggest IPO of all time of India

Who are the Key Players in the IPO Book Building Process?

1. Issuer:

• Role: The company intending to go public.
• Responsibilities:
  • Decides to use the book-building process.
  • Appoints book running lead managers (BRLMs).
  • Provides necessary information for the prospectus.

2. Book Running Lead Managers (BRLMs):

• Role: Financial institutions or investment banks appointed by the issuer.
• Responsibilities:
  • Coordinate and manage the entire book-building process.
  • Assist in drafting the prospectus.
  • Decide on the price band in consultation with the issuer.
  • Market the IPO to institutional and retail investors.
  • Oversee the bidding process.
  • Facilitate communication between the issuer and investors.

3. Registrar:

• Role: An entity responsible for processing and confirming applications.
• Responsibilities:
  • Verifies and validates bid details submitted by investors.
  • Allots shares to successful bidders.
  • Coordinates with depositories for the credit of shares to investors’ demat accounts.

4. Bankers to the Issue:

• Role: Financial institutions responsible for collecting bid amounts from investors.
• Responsibilities:
  • Collect application money from investors.
  • Transfer funds to the issuer’s account.

5. Investors:

• Role: Individuals and institutions participating in the bidding process.
• Responsibilities:
  • Submit bids within the specified price band.
  • Express interest in the IPO by indicating the quantity of shares and the price they are willing to pay.

6. SEBI (Securities and Exchange Board of India):

• Role: Regulatory authority overseeing securities markets in India.
• Responsibilities:
  • Sets guidelines and regulations for IPOs, including those related to book building.
  • Ensures transparency and fairness in the IPO process.
  • Monitors compliance with regulatory requirements.

7. Depositories:

• Role: Organizations that facilitate the holding of securities in electronic form.
• Responsibilities:
  • Work with registrars to credit allotted shares to investors’ demat accounts.
  • Ensure the smooth transfer and settlement of shares.

8. Underwriters:

• Role: Financial institutions that agree to purchase any unsold shares in case of undersubscription.
• Responsibilities:
  • Provide a commitment to purchase unsubscribed shares, ensuring the success of the IPO.

9. Retail Investors:

• Role: Individual investors participating in the IPO.
• Responsibilities:
  • Bid for shares at the cut-off price or within the specified price band.
  • Contribute to the overall demand for shares.

10. Institutional Investors:

• Role: Large investment entities, such as mutual funds, insurance companies, and foreign institutional investors (FIIs).
• Responsibilities:
  • Participate in the bidding process, indicating the quantity of shares and the price they are willing to pay.
  • Contribute significantly to the overall demand and pricing dynamics.

11. Credit Rating Agencies:

• Role: Organizations that assess the creditworthiness of the issuer.
• Responsibilities:
  • Provide credit ratings for the issuer’s financial instruments.
  • Influence investor confidence and interest in the IPO.

Conclusion

The IPO book-building process stands as a dynamic and market-responsive mechanism that has transformed the landscape of initial public offerings. By allowing companies to determine the price of their shares through investor participation and market demand, this method offers a level of flexibility and precision that traditional fixed pricing often lacks.

In conclusion, the IPO book-building process is not merely a financial transaction. It’s a strategic dance between companies and the market. As financial landscapes evolve and markets continue to adapt, the book-building process remains a powerful tool for companies seeking to go public, ensuring a delicate balance between pricing certainty and market-driven dynamics

Frequesntly Asked Quetions (FAQs)

Q1: What is IPO Book Building?

A1: IPO Book Building is a process through which a company determines the price of its shares before launching an Initial Public Offering. The company, with the help of book running lead managers (BRLMs), invites investors to submit bids within a specified price range, leading to market-driven price discovery.

Q2: How does the book-building process work?

A2: The book-building process involves setting a price band for the IPO. Investors, both institutional and retail, then submit bids at the price they are willing to pay within this range. The final issue price is determined based on the demand at different price levels, ensuring optimal price discovery.

Q3: What is the difference between fixed pricing and book building?

A3: In fixed pricing, the company determines a specific price for its shares. In book building, a price range is set, and investors bid within this range. The final issue price is determined based on the bids received during the book-building period.

Q4: Why do companies opt for the book-building process?

A4: Companies choose the book-building process for several reasons, including market-driven pricing, optimal valuation, flexibility in adjusting the price range, increased investor participation, and efficient capital raising.

Q5: Who are the key players in the IPO book-building process?

A5: The key players include the issuer (company going public), book running lead managers (BRLMs), registrar, bankers to the issue, investors (both retail and institutional), regulatory bodies like SEBI, depositories, underwriters, credit rating agencies, and retail and institutional investors.

Q6: What is the role of SEBI in the book-building process?

A6: The Securities and Exchange Board of India (SEBI) is the regulatory authority that oversees the securities markets. SEBI sets guidelines and regulations for IPOs, ensuring transparency and fairness in the book-building process.

Q7: Are all IPOs conducted through book building?

A7: No, not all IPOs are conducted through book building. Companies can choose between fixed pricing and book building based on their preferences, market conditions, and regulatory requirements.

Q8: How is the final issue price determined in the book-building process?

A8: The final issue price is determined based on the bids received during the book-building period. It is often set at the price where the demand for shares is the highest, ensuring optimal price discovery.

Q9: What is the role of retail investors in the book-building process?

A9: Retail investors participate by bidding for shares at the cut-off price or within the specified price band. Their involvement contributes to the overall demand for shares.

Q10: Can the book-building process be extended?

A10: Yes, some IPOs may have an extended book-building period to allow for additional investor participation and bid submissions.

Check out Basics of IPO if you want to know more about how IPOs work in India.

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