What is Book Building Process in IPO

How Does the Book Building Process Work

The Book Building process involves the following step-by-step procedure:

Step 1: Hiring an Underwriter

Companies typically bring on investment banks as underwriters for their IPOs. The underwriter helps determine the size of the issue and sets a price range. Investors then place their bids within this range.

Step 2: Bidding

The underwriter, along with the issuer, invites investors to submit bids for the shares being sold through the IPO based on the given price range.

Step 3: Setting the IPO Price

The underwriter keeps an order book that records all investor bids. They usually use a weighted average method to determine the final IPO price.

Step 4: Allotting Share

Once all bids are received, the IPO price is finalised. Investors whose bids meet or exceed the cut-off price are allotted shares. Those who bid above the cut-off receive a refund for the excess amount.

Why Do Companies Prefer the Book Building Process

Indian companies choose the Book Building process for setting IPO share prices for several key reasons. These are as follows:

• Market-Driven Pricing

The Book Building process sets the share price based on investor interest and market conditions rather than a fixed price. This approach ensures that the IPO price reflects the actual market value of the shares, providing a more precise and equitable valuation.

• Enhances Investor Confidence

The transparency of the Book Building can increase the trust of investors. Knowing that market demand determines the price, rather than an arbitrary decision by the company, encourages more investor participation.

• Minimises Underpricing

Fixed-price offerings can lead to underpricing or overpricing, causing significant price fluctuations after the IPO. The Book Building method helps reduce these risks by aligning the issue price with market demand, resulting in a more stable post-IPO performance.

• Efficient Share Allocation

The process allows for a more strategic allocation of shares among different investor types. Institutional investors, with their market expertise and strategies, play a significant role, leading to a more balanced distribution of shares.

• Regulatory Framework

The Securities and Exchange Board of India (SEBI) provides clear guidelines for the Book Building process in IPOs, ensuring it is well-regulated and structured. This regulatory support promotes fairness and transparency throughout the process.

• Valuable Market Feedback

Companies gain important insights from investor feedback during the Book Building phase. This feedback helps understand investor expectations and market sentiment, which can be crucial for future company strategies and decisions.

Advantages of Book Building in IPOs

The following are some advantages of the Book Building method for IPOs:

• Efficiency

The Book Building process determines the issue price based on investor demand, making it more efficient than fixed-price issues.

• Accuracy

Using this process, companies can set an IPO price closer to its true intrinsic value, minimising the risk of overpricing or underpricing.

• Maximises Share Price

This process allows companies to achieve the highest possible price for their shares. High bids from investors can drive up the share price.

• Quick Capital Access

Book Building enables companies to quickly secure capital, streamlining the fundraising process.

• Clear Pricing for Retail Investors

The process sets the issue price before it reaches retail investors, which eliminates any confusion about pricing at the time of the issue.

• Reduces Marketing Costs

Since this process is based on demand, it lowers marketing expenses. However, companies will still need to compensate underwriters for their services.

The Bottomline

The Book Building process stands out as an efficient way for companies, with the support of investment bankers, to price their shares in IPOs. It allows investors to actively participate in valuing the shares by submitting bids. This process not only enhances transparency but also ensures that the shares are priced fairly and accurately.