Understanding Book Building
Book building is a process used by a company that appoints an underwriter (that is an investment bank) to decide the appropriate price at which their shares will be offered to the public during an IPO (initial public offering) or follow-on public offering. The underwriter creates a book by inviting institutional investors to submit their bids for the share’s final price. Preferred over the earlier ‘fixed pricing’ method where the share price was set before investors became involved, in book building the price discovery process involves collecting and recording investor’s demand for shares before deciding a final issue price. Major stock exchanges widely endorse this method as the most effective way to price securities.
What is the Process of Book Building?
- The issuing company selects an investment bank to act as the underwriter. The underwriter determines a price range for the shares and prepares a prospectus to distribute to institutional investors.
- The underwriter invites large investors, such as large-scale buyers and fund managers, to place bids. Investors specify how many shares they want and the price they are willing to pay.
- The underwriter compiles a ‘book’ and reviews all the bids to decide the overall demand and uses this information to calculate the final price for the shares, known as the cutoff price.
- To ensure transparency, the underwriter publishes details of all the bids received.
- Shares are then distributed to the investors whose bids were accepted.
- The price determined through the book building process is not guaranteed to be the final price, nor is it compulsory for the company to use this price for the IPO.
Accelerated book building is another form of book building that is a fast-track method used by companies when they need immediate funds, such as when they want to acquire another company. The funds are raised by selling shares (equity) rather than borrowing money (debt). The offer period is very brief, usually lasting only one or two days and the involvement of marketing is minimal. The process is that the investors submit their bids, and the issuer selects the highest bid. The issuer awards the shares to the investor who offers the highest price, ensuring the company gets the necessary funds quickly.
Advantages of Book Building
- Book building helps determine a fair and accurate price for the IPO by collecting bids from institutional investors, indicating real market demand.
- The process allows for a better understanding of investor interest, leading to more accurate pricing and reducing the risk of underpricing or overpricing.
- It allows the issuing company to choose quality investors and reduces costs that would otherwise be spent on marketing and advertising.
- It provides a clear process for setting the price in front of the public, enhancing transparency and trust among investors and consumers.
