What is Book Building Process in an IPO?

When a company decides to go public for the first time, determining the price of its shares becomes a pivotal task. Two primary methods are used: the fixed price method and the book-building method. Dive into this blog to go through the nuances of the book-building process and gain a deeper understanding of the IPO market.

Meaning of Book Building

Book building is a process in which the company, along with the underwriters, determines the price of the issue by gauging the investors' demand. Under this process, a price band gets set for the IPO based on factors like company valuation, investor interest, the company’s financial performance, and more. 

Investors bid for shares in the IPO within this price band, which leads to a price discovery process. This allows for a more transparent and market-driven determination of the IPO price, reflecting the true demand for the company's shares among investors.

Book Building Process

The process of book-building for IPOs is lengthy but is a preferred option for IPO pricing in India. The steps in the book building process are explained below. 

• The starting point of the book-building process is to appoint an investment bank that acts as an underwriter for the IPO. 

• The company and the underwriters, decide on a price range rather than a fixed price for the IPO shares based on market analysis, demand forecasts, and the company's valuation.

• The IPO book opens for a specified period during which institutional and retail investors can place their bids within the price range, indicating the quantity they want and the price they are willing to pay. Investors can revise bids during the bidding period.

• The final price of the IPO shares is determined based on the bids received. 

• After the bidding closes, shares are allocated to investors based on their bids, ensuring fair distribution according to the bidding price and quantities requested.

Why Companies Choose Book Building for IPOs?

Optimal Price Discovery

   - Helps find the true share price based on market demand

   - Investors bid at various price levels

   - Reduces risks of underpricing or overpricing

Broad Investor Participation

   - Attracts diverse investors (institutional, retail, high-net-worth)

   - Increases chances of a successful IPO

   - Improves post-listing market liquidity

 Efficiency and Transparency

   - Provides real-time insight into investor demand

   - Builds investor confidence

   - Creates a fair, competitive market environment

Book building aligns the interests of the company, underwriters, and investors, maximising capital raised while satisfying investor demand.

Difference Between the Book Building Process and the Fixed Price Issue

Book-building processes and fixed-price issues in an IPO are essentially the different types of pricing in an IPO. The key differences between the two are:

What are the Pros and Cons of the Book Building Process?

A step towards a better understanding of the book-building process includes analysing its pros and cons. Here is a brief list of the pros and cons of the IPO's book-building method.

Advantages of the Book building process

The key advantages of the book-building process include,

• Proper Pricing of the IPO: This process allows the determination of IPO price based on investor demand, ensuring it reflects true market value.

• Efficiency: The book-building process streamlines the IPO process by consolidating investor bids and reducing administrative burdens compared to fixed-price offerings.

• Enhanced market perception:  A well-executed book building process enhances market perception and investor confidence potentially leading to a more accurate valuation.

• Transparency: This process ensures higher transparency through the bidding process and the price range, thereby fostering confidence in the fairness of the IPO.

Disadvantages of the Book building process

The key disadvantages of the book-building process are,

• Time-Consuming: This process typically takes longer than a fixed price issue due to the bidding period and price discovery phase.

• Higher Costs: Companies may incur higher costs associated with marketing, legal, and administrative expenses compared to traditional IPO methods.

• Risk of Underpricing: There is a risk that the IPO may be underpriced if investor demand is significantly underestimated which can potentially lead to missed fundraising opportunities for the company.

• Complexity of the Process: It is a more complex process compared to a fixed price issue and requires a thorough understanding and management of market dynamics and investor behavior.

SEBI Guidelines for the Book Building Process

The book-building process is the method by which a company determines the prices for its shares under the IPO. This process is defined according to the SEBI guidelines to ensure transparency and a streamlined process. A few key SEBI guidelines for the book-building process in IPO are mentioned below.

• Meet SEBI eligibility and compliance standards

• Set a price band with an upper limit not exceeding 20% of the lower limit

• File DRHP and RHP with SEBI, making information public

• Choose between 100% book building or 75% book building with a 25% fixed price

• Keep the bidding period open for 3-10 working days

• Disclose price band 2 days before bidding starts

• Reserve specific share percentages for different investor categories

• Achieve at least 90% subscription of total issue size

•  Appoint a Book Running Lead Manager (BRLM)

•  Allocate shares based on bids and process refunds within 6 days of IPO closing

Conclusion

The book-building process is a dynamic and market-driven approach to pricing and allocating shares during an Initial Public Offering (IPO). While the book-building process involves more complexity and time compared to fixed price issues, it is not free from limitations. Therefore, investors should know the book-building process in detail to make informed decisions and take advantage of the investing opportunities through an IPO.