Companies in today’s fast-paced world frequently look for new ways to raise money for growth and expansion. The book-building procedure for Initial Public Offerings (IPOs) is one such common strategy.
This article seeks to offer a thorough explanation of the book building process for IPO, its method, subtypes, comparison with fixed pricing issues, and the accompanying benefits and drawbacks.
What is the meaning of Book Building?
The process of deciding the price at which securities, such as stocks, are sold to the public during an IPO is referred to as book building process. Investment banks or underwriters work with the issuing firm to create a “book” or demand for the shares of these companies among institutional and retail investors under this method.
What is the process involved in Book Building?
The book-building process typically involves the following steps:
Appointment of Lead Managers
Lead managers or underwriters are chosen by the company issuing the shares and are in charge of overseeing the IPO procedure and working with regulatory bodies.
The appointed lead managers understand and create the demand for the company’s securities and determine the indicative price range based on interest expressed by potential investors. This range reflects a floor price and a cap price.
Qualified institutional buyers (QIBs), non-institutional investors, and retail individual investors can place bids within the price range set in the previous step. The investors specify the quantity and the price at which they are willing to purchase the shares during this period.
Book Building Period
The book building period typically lasts a few days, during which investors can revise their bids. The lead managers gauge the bids received at various price levels.
After the book building period ends, the lead managers allocate shares to investors based on the demand, bidding price, and relevant regulations. The final price at which shares are issued is known as the cut-off price.
Why do companies opt for the book-building process?
Companies opt for the book-building process for the following reasons:
Efficient Price Discovery
Book building process enables companies to gauge investor interest for IPOs and ascertain the most appropriate price for their shares based on market demand.
Enhanced Investor Participation
The process allows for participation from a wider range of investors, including institutional and retail investors, thereby increasing the overall subscription and liquidity of the shares.
Flexibility is provided via book building, which enables the issuing business to modify the price range in reaction to investor demand and market conditions.
Also, read about IPO Grey Market Premium
What are the subtypes of Book Building?
Accelerated Book Building
Accelerated book building is a form of book building that is employed when there is a pressing need to finish the offering quickly. It focuses largely on institutional investors and has a shorter book building period.
Partial Book Building Process
In this subtype, only a portion of the issue is set aside for book building; the remainder is made available at a fixed fee. This enables the use of both fixed pricing systems and book building process.
Difference Between the Book Building Process and the Fixed Price Issue
The key differences between the book building process and the fixed price issue are as follows:
|Basis||Book Building Process||Fixed Price Issue|
|Price Determination||Determined through the bidding process based on investor demand.||Predetermined by the issuing company.|
|Investor Participation||Broad range of investors can participate, including institutional and retail investors.||Limited participation of specific category of investors.|
|Flexibility||Price range can be adjusted by the lead manger based on market response.||Fixed price offered to all investors.|
|Price Discovery||Efficient price discovery based on market demand and investor bidding.||Limited price discovery because of predetermined price.|
|Complexity||Involves multiple steps and coordination between various stakeholders.||Relatively simpler process with fewer steps involved.|
|Volatility Risk||Fluctuating investor demand and market conditions can introduce volatility and uncertainty.||Less susceptible to market fluctuations and volatility.|
Pros and Cons of Book Building Process in IPO
Benefits of Book Building Process:
Efficient Price Discovery
Book building ensures a fair price is determined based on market demand, optimizing the offering price.
Increased Investor Interest
The process attracts a diverse range of investors, leading to higher subscription rates and increased liquidity.
Companies can adjust the price range based on market conditions, ensuring optimal pricing.
Drawbacks of Book Building Process
It is possible that the book building process is more complicated than a fixed pricing issue since it entails several processes and calls for collaboration between multiple stakeholders.
Erratic investor demand and market conditions during the book building period can result in volatility and uncertainty.
The book building process is a common IPO method on the stock market because it promotes greater investor engagement and effective price discovery. Companies choose for this process because of its numerous advantages, irrespective of some drawbacks it might have over alternate methods.
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Investors put bids during book building stating the amount and price at which they are ready to buy shares. The final cut-off price is decided by the lead managers after they examine the bids received.
In book building, the price is determined through a bidding process based on investor demand, while in a fixed price IPO, the price is predetermined by the issuing company.
75% book building refers to the process where 75% of the securities offered are reserved for allocation through the book building process, while the remaining 25% are offered at a fixed price. This is an example of a partial book building process.
In book building, investors place bids specifying the price and quantity they are willing to purchase, while in an auction, investors bid for the securities by specifying the price they are willing to pay. Under book building, the lead manager controls investor selection and distribution of shares, unlike auction.
The floor price is the minimum price at which investors can place bids during the book building process.
The bid price is the price at which an investor is willing to purchase the securities during the book building process.
Reverse book building is a process where the company buys back shares from the public, aiming to delist from the stock exchanges. Book building, on the other hand, is the process of issuing shares to the public during an IPO.