Book Building Meaning
Book Building is a process that helps companies discover the price of its security when its shares are being offered for sale in an IPO with the help of investment bankers and is recommended by major stock exchanges and regulators because it is the most efficient mechanism to price securities in the market.
How does the Book Building Process Work?
When a company has planned to list its shares on the stock exchanges for the first time via IPOIPOInitial Public Offering (IPO) is when the shares of the private companies are listed for the first time in the stock exchange for public trading and investment. This allows a private company to raise the capital for different purposes., the company management has to decide various things to get its share listed on the stock exchange such as issue size, share price, etc. and to get through all this process; first company management has to appoint underwriter to help in the listing process.
Let’s see in the detail each step involved in the book-building process.
- Hiring Underwriter
Firstly, the Issuing company needs to hire an Investment bankInvestment BankInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc. that acts as an underwriterUnderwriterThe underwriters take the financial risk of their client in return of a financial fee. Market Makers like financial institution and large banks ensure that there is enough amount of liquidity in the market by ensuring that enough trading volume is there.. With the help of issuing company management, the Investment bank identifies the size of the issue and determines the price range of the securities. An Investment bank drafts the company prospectus, which includes all the relevant details about the issuing company such as financials, Issue size, Price range, future growth perspectives, etc. The price range of share consists of floor price (Lower end of the price range) and Ceiling price (Upper end of the price range).
- Investor’s Bidding
Investment bank invites investors. Usually, these are high net-worthNet-worthThe company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus. individual & fund managers to submit their bids on the number of shares they are willing to buy at the various price level. Sometimes, it is not a single investment bank that underwrites the entire issue. Rather, the lead investment bank is engaged with other investment banks who use their networks to tap a large number of investors for the bidding process.
- Share Pricing
After all the bids are collected by the investment bank at different price levels, they evaluate the aggregate demand for the issue from the submitted bid. To price the share of the issue, the underwriter uses the weighted-average method to arrive at the final price of the share. This final price is also known as ‘Cut-Off price.’ If there is a good response for any issue by investors, the Ceiling price is usually a ‘Cut-off Price.’
- Biding Process Transparency
Most of the regulators and the stock exchangesThe Regulators And The Stock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ. in the world require companies to make public the details of the bidding process. It is an underwriter duty to publicize the details of the bids submitted by the investor to purchase the shares of the issue.
- Allotment & Settlement
Lastly, the allotment process begins by allocating the shares of the issue to the accepted bidders. Now, as you know, initially, investors had bid for this issue at the different price range, but the settlement process ensures that all allotments happen at the cut-off price of this issue. An investor who had bidden in excess to cut off price, their excess money is returned, and investors who had bidden less than the cut-off price, investment bank ask them to pay the difference amount.
Other Subtypes of Book Building
The following are subtypes of book building.
#1 – Accelerated Book Building
An Accelerated book building process can be used by the companies to obtain quick financing from the capital marketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets.. This can be the case when a company is unable to finance its short term project via the debt financing route. So, the issuing company contacts a number of investment banks that can act as underwriters on the evening prior to the intended placement. Under this process, the offer period is open only for a day or two days and have no time for marketing for an issue. The underwriter overnight contacts their networks & give detail about the current issue to institutional investorsInstitutional InvestorsInstitutional investors are entities that pool money from a variety of investors and individuals to create a large sum that is then handed to investment managers who invest it in a variety of assets, shares, and securities. Banks, NBFCs, mutual funds, pension funds, and hedge funds are all examples.. If this investor finds this issue interesting, then allotment happens overnight.
#2 – Partial Book Building
As the partial book building itself says that issue book built partially, where investment banker only invites bids from the selected group of investors & based on their bids, they take the weighted average of the prices to finalize the cut-off price. Then other investors, such as retail investorsRetail InvestorsA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making., take this cut-off price as a fixed price. So, under the partial book-building process, the bidding happens with a selected group of investors.
Advantages of Book Building
The following are the advantages of the book-building process over a fixed price mechanism.
- The most efficient way to price the share in the IPO market;
- The price of the share is finalized by the aggregate demandAggregate DemandAggregate Demand is the overall demand for all the goods and the services in a country and is expressed as the total amount of money which is exchanged for such goods and services. It is a relationship between all the things which are bought within the country with their prices. by investors, not by the fixed price set by the company management.
Disadvantages of Book Building
The following are the disadvantages of the book-building process over the fixed-price mechanism.
- High cost involved in the book-building process as compared to the fixed-price mechanism;
- The time period is also more in the book booking process as compared to the fixed-price mechanism.
Important Point to Remember
- Book Building is a process of discovering the price of the security that being offered for sale in an IPO market.
- The Price range of security consists of Ceiling price (Upper end of the price) & Floor price (Lower end of the price).
- The final price at which shares are allocated to investors is known as ‘Cut-off Price.’
Book building is one of the most efficient mechanisms by which companies, with the help of the investment banker, price their share in IPOs, and also it is recommended by all the major stock exchanges and regulators. It also helps investors to value the price of the shares by submitting the bids to the underwriter, which is not possible if the company chooses a fixed-price mechanism to price its share.
This has been a guide to what is book building and its meaning. Here we discuss how does book building process works for the company, along with its advantages and disadvantages. You can learn more from the following articles –