Every company must go through the initial public offering procedure in order to sell their shares to the general public for the first time (IPO). A company may choose between a fixed-price IPO and a book-built IPO, which are two forms of initial public offerings. In a fixed-price IPO, the company determines the price at which the shares will be sold to investors. Yet, the price discovery process is fundamentally different from a book-built IPO. Besides this you should also check the factors before you invest in IPO as it can guide you and safeguard your interest.
All other businesses, with the exception of SME companies, typically opt for the book-built IPO process. Are you curious about the book-building procedure in an IPO and the reasons businesses typically choose it?
No worries as we are here to explain everything to you. Keep reading!
Book building process in IPO
Companies that are releasing their shares to the public for the first time employ the book-building procedure as a price discovery method. Here, a business establishes a price range with a floor and a ceiling. Investors who want to subscribe to the public offering are encouraged to bid at these levels.
The business establishes the final cut-off price using a weighted average technique after the issue closes, in collaboration with Book Running Lead Managers (BRLMs). When shares are issued to investors, they are at the final cut-off price. Here is a fictitious illustration of how the book-building procedure is carried out in an IPO.
We can learn it from an example: suppose a company issues 5000 shares to the public via IPO. It sets a price band of Rs. 300 to 350 per share. If an investor is interested, they can apply for a price between 300 and 350 dollars. Below is a fictitious illustration of the investors' offers.
|
Investor |
No. of shares applied |
Bid Price |
|
1 |
1000 |
310 |
|
2 |
500 |
320 |
|
3 |
500 |
330 |
|
4 |
2000 |
340 |
|
5 |
1000 |
350 |
|
6 |
500 |
340 |
|
7 |
500 |
330 |
|
8 |
500 |
310 |
|
Total |
6500 |
The corporation then determines the final cut-off price by calculating the weighted average cost of all the bids it has received. Shares of the company will be distributed to investors who bid at or above the final cut-off price. Moreover, bidders who placed their bids below the final cut-off price will not get any shares. Any funds that were put on hold in their account because of the IPO will be unlocked.
Why do businesses choose the book-building process?
There are numerous reasons why businesses typically choose a book-built IPO. Below is a brief overview of a few of them.
-
Effectiveness
A book-built IPO is significantly more effective than fixed-price offerings since the issue price is decided by examining the IPO's demand.
-
Transparency
With a fixed-price IPO, the business does not reveal the pricing strategy it has used. On the other hand, the book-building procedure is quite open, with the corporation making the details of the bids available to the public.
-
Lower cost
A corporation must do comprehensive calculations and considerations to determine the IPO price in a fixed-price IPO. The cost of the public issue may dramatically rise as a result of these additional measures.
By choosing the book-building method, a business may let market forces determine the price, which lowers the total expenditures the business will incur.
-
Accurate
The likelihood that a firm will set its IPO price at an undervalued or inflated level is high. The corporation can, however, reach a price that's probably closer to its true inherent value by choosing the book-building procedure.
Fixed price issue Vs book building issue
Here are some of the main differences between fixed price issues and book-building issues.
|
Fixed Price Issue |
Book Building Issue |
|
|
Pricing |
The share price, which is printed in the order document, is set on the first day of the offering. |
There is no set price for shares. Only the price range is predetermined. Following the submission of bids, the price is set. |
|
Demand |
It becomes known after the issue is resolved. |
That is everyday knowledge. |
|
Payment |
A full upfront payment should be made. The allotment is followed by a refund. |
Payment can be made once the allocation has been made. |
|
Reserved allocations |
50% of the allocations are set aside for investments under 2 lakh, with the remaining allocations going to big-dollar investors. |
For QIBs, 50% of allotments are set aside. 35% goes to small investors, with the remaining funds going to other investor types.
|
Partial and accelerated book building
The book-building process has two types and these are as follows:
Partial book building
It is a variation of it. Instead of inviting bids from the general public, bids from certain financing institutions are invited and approved in this case. The cut-off prices are then established based on their offers, and for ordinary investors, these prices serve as the ultimate price. This method has low expenses and a high level of effectiveness.
Accelerated book building
When a business needs money but debt financing is not the best option at the time, this type is typically chosen. Instead of bidding, it is typically performed as an auction. Most of the time, the process is finished in a matter of one or two days.
Conclusion
You should now be familiar with how an IPO's book-building process works. Check the "cut-off price" box in the IPO application every time you enroll in a book-built IPO issuance. By ensuring that your bids are submitted at the cut-off price, whatever it may be, you will increase the likelihood that your bids will be accepted.
With this you should also know about IPO underpricing as the demand from investors drives the price up to its market value.
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