What is Book Building Method?

In the world of Initial Public Offerings (IPOs), there are two main methods companies use to raise funds from the public—book building and fixed-price issues. Book building is a dynamic method that helps companies decide the price of their shares based on investor demand. It’s a flexible and transparent process that allows the market to determine the price, ensuring a fair valuation for both companies and investors. This blog will explain the book building method, how it works, its differences from the fixed-price issue, and why companies prefer it.

Overview of Book Building Method?

The book building method is a way companies use to decide the price of shares during an Initial Public Offering (IPO). Instead of fixing a set price for the shares, companies offer a price range. 

Investors then bid for the number of shares they want and suggest a price within that range. Based on the bids they receive, the final price of the shares is decided.

This method helps the company understand how much demand there is for its shares, making the pricing fairer for everyone. It’s a flexible process where both companies and investors have a say. 

The company gets to raise the funds it needs, and investors can bid for shares at a price they feel is reasonable. This method is widely used in stock markets because it gives a clear picture of demand and sets the price based on what investors are willing to pay.

In India, the book building method is a popular choice because it adds transparency and ensures that the market plays a role in setting the final share price. It helps avoid overpricing or underpricing shares, making it a more efficient way to raise capital.

Example of How the Book Building Method Works

Imagine a company planning to issue 25,000 shares in an IPO. The price range is set between Rs. 400 and Rs. 450 per share. Investors can place bids within this range, and here’s a snapshot of how they bid:

Here, investors have requested a total of 22,700 shares, but the company is offering 25,000. After evaluating the bids, the company sets a cut-off price. Those who bid at or above this price will receive shares, while investors who bid below it won’t get an allotment.

This approach helps ensure that shares are distributed in a way that matches investor demand, making the process more efficient and fair for everyone involved.

Steps of Book Building Process

The book building process may sound complex, but it follows a clear set of steps:

1. Setting the Price Range

First, the company sets a price range for the shares, called the price band. For example, the price could be between ₹100 and ₹120 per share. This gives investors an idea of what they might pay for each share.

2. Placing Bids

Next, investors interested in buying shares place their bids. They decide how many shares they want and at what price within the given range. For instance, if an investor wants 1,000 shares at ₹110, they can submit that bid.

3. Collecting the Bids

After all bids are submitted, the company collects the data in a “book.” This book tracks how many shares investors are asking for at each price point. This step helps the company understand the overall demand for its shares.

4. Deciding the Final Price

Once all bids are gathered, the company and its underwriters review them to determine the final share price. The final price is usually based on the highest demand from investors. This price is known as the “cut-off price.”

5. Allotting Shares

After the price is decided, the company allocates shares to investors. Depending on the demand and the bids submitted, some investors may get all the shares they asked for, while others may get a reduced amount. Retail investors, or individual buyers, sometimes get a small preference in the allotment.

Also Read: How Do Index Funds Work?

Why Do Companies Opt for the Book-Building Process?

Here are some key reasons why companies choose the book-building process:

Fair Market Pricing

Companies can determine a fair price for their shares based on what investors are willing to pay, making the pricing market-driven and balanced between supply and demand.

Better Control Over Demand

By analysing bids from investors, companies can decide how many shares to issue and at what price. This helps them avoid the risk of not selling enough shares or setting the wrong price.

Boosts Investor Trust

The transparency of the process builds trust among both large institutional investors and individual buyers, helping ensure a successful IPO.

Efficient Capital Raising

The book-building process helps companies raise significant capital quickly, while allowing investors to influence the final price of the shares.

Conclusion

The book building method is a smart and flexible way for companies to raise capital through an IPO. It provides transparency, ensures fair pricing based on market demand, and helps companies gauge investor interest. By using the book-building process, companies can maximise the success of their IPO while offering investors a transparent and efficient way to invest in new shares. This method stands in contrast to the fixed-price issue, giving both parties more confidence in the final valuation.