What is Book Building Process in IPO

What is Book Building Process in IPO

Book building is the process by which an underwriter sets the price at which shares must be sold in an Initial Public Offering (IPO). As part of the price discovery process, the underwriter must solicit bids from diverse institutional investors, such as fund managers. However, there is always the risk of overpriced or undervalued shares. In this blog, we will explain everything about the book building process in IPO and why companies prefer it. 

Book Building Process Meaning and Example

A book building process emerges as an important system for determining prices during the initial public offerings. The company generally sets a price band during a subscription period to encourage investors to bid within the upper and lower limits. The company works with the Book Running Lead Managers (BRLMs) to determine the final cut-off price using a weighted average method as soon as the subscription period expires. Investors are issued the shares at this final cut-off price.

Let us explain this with an example: Suppose a company plans to issue 20,000 shares via an IPO, and they have set the price band between Rs. 500 to Rs. 550 per share, within this range, investors can apply for shares at any price. The following is a simplified representation of investors' bids:

Investors No. of Shares Applied Bid Price
Investor 11000Rs. 500
Investor 21000Rs. 510
Investor 32000Rs. 520
Investor 44000Rs. 550
Investor 53000Rs. 500
Investor 62000Rs. 510
Investor 74000Rs. 540
Investor 82000Rs. 510

The company calculates a weighted average price and sets the final cut-off price. Investors who bid on or above the final cut-off price are allotted shares, while those who bid below it do not receive any allocation. 

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Table of Content

  1. Book Building Process Meaning and Example
  2. Book Building Process
  3. Difference Between the Book Building Process and the Fixed Price Issue
  4. Why do Companies Opt for the Book-Building Process?
  5. What does the SEBI have to say about the Book-Building Process?

Book Building Process

There are several keys of book building process steps to follow in the complex book building method of IPO:

  • A company's issuing bank acts as its underwriter, to determine the price range for its securities.
  • The investment bank sends invitations to large-scale buyers, fund managers, and other interested parties to submit bids on the shares within the allocated price range.
  • The aggregated demands for the issue from the submitted bids are meticulously compiled and evaluated, forming what is known as the “book.” The final price of the security, termed as the cut-off price, is determined through this process.
  • The underwriter presents all the bid details to the public, encouraging transparency and ensure stakeholders remain informed throughout the process.
  • Afterward, these shares are allocated to the accepted bidders based on their bids at the final cut-off price.
  • Please note that the prices determined in the book building process may not certainly signify the optimal prices, and the company is not obliged to use these prices for an IPO. 

Difference Between the Book Building Process and the Fixed Price Issue

Here is the differences between the book building method of IPO and fixed price issue: 

Particulars Book Building ProcessFixed Price Issue
FlexibilityThe book building process offers flexibility to set the issue price based on market demand.It gives limited flexibility, with a fixed price.
Investor ParticipationIt encourages investors to take part by allowing them to contribute to price discovery.There is limited investor involvement in setting the price, as mostly the price is already fixed. 
Price DiscoveryAllows for price discovery by reflecting investor demand at various levels.It provides limited insight into investor demand before pricing.
Market EfficiencyEnhances market efficiency by aligning the price with investor demand.This may result in incorrect pricing if market conditions undergo significant changes after the price is set.
Risk ManagementHelps mitigate risk by adjusting the price based on market dynamics.It carries a higher risk of underpricing or overpricing if the fixed price does not accurately reflect market conditions.

Why do Companies Opt for the Book-Building Process?

Companies opt for the book building process due to the following reasons: 

  • Price Discovery: With the book building process, companies can easily measure investor demand and set an ideal issue price, promoting transparency and fairness.
  • Flexibility: As companies are allowed to adjust the issue price based on market conditions and investor interest, the book building method offers flexibility in pricing.
  • Efficient Allocation: The book building process promotes an efficient allocation of shares by minimising underpricing and maximising capital raised, as the book accurately reflects investor demand. 

What does the SEBI have to say about the Book-Building Process?

Under the rules set by the Securities Exchange Board of India (SEBI), companies can choose between a 75% book-build IPO or a 100% book-build IPO. In a 100% book build IPO, the offering price is determined using the book building method. Similarly, in a 75% book build IPO, pricing for 75% of the offering is established through book building. However, for the remaining 25% of the offering the company has the flexibility to set the price after determining it through the book building process. 

When it comes to Initial public offerings (IPOs), the book building process is an essential component that helps companies in preparing for their IPOs. By considering investor preferences and gaining insights into market dynamics, companies can determine the share price. This method ensures fairness and facilitates efficient share distribution, fostering trust and confidence in the IPO system. By using stock market app you can monitor and participate in IPO market activities.

FAQs for Book Building Process in IPO

The book building method is a process by which an underwriter attempts to determine the price at which an Initial public offering (IPO) will be offered.

The disadvantage of book building is, if the investment bank is not transparent in its allocation process of securities. 

No, you cannot modify or change the bid price after submitting the IPO application.

The main benefit of book building is, it helps to achieve better price discovery, through the gathering and analysis of investor bids at different price levels.

If you bid below the cut-off price, your chances of receiving an allotment of shares will be uncertain.