Book building can also be called the process of price discovery. Under this, the company collects bids at various prices from the investors at the time when the IPO is open. The prices may be above or equal to the floor price. Once the bidding is closed, the price of the shares is determined.
The book-building method was introduced by SEBI (Security And Exchange Board of India) in October 1995. It helps in the preparation and implementation of the IPO filing by providing detailed information about the company’s financial status, business strategies, and future plans.
This blog explains the exact meaning of book-building and discusses the steps in the book-building process.
What Do You Mean by Book Building?
In most layman’s terms, we can define book building as the collection of information regarding how much the investors want and what they are willing to pay. And by using that information, a demand curve is built by the investment bankers or the underwriter. Based on this information alone, they are able to look at the X amount of shares that the company is going to offer, and, based on the amount of interest in this issue, they can price it at X rupees. So, by using this information available, they can accurately project what is a good price and what will be met in the market with strong demand.
Book building is a part of a three-step process that is required to complete an Initial Public Offering. The other two processes are the auction and fixed price offering.
An auction is a process in which the company sells its shares to the highest bidder. The company will not sell all of its shares at one time, but it can sell as many or as few shares as it wants. In order for an IPO to be successful, investors must bid on and purchase enough stock that would make them eligible for future dividends.
Fixed price offerings: Fixed price offerings are a type of offering that is almost always used in the initial public offering (IPO) process. The fixed price offer is an option for companies to sell shares at a set price, which is usually higher than the current market value of the company. In this way, investors can buy shares at a lower cost and still make money on their investment as long as they hold onto them until after the IPO date.
The book-building process includes all the steps that will help the company to build its book. They can also use some other strategies like selling shares, options, and other things that may help them to get listed on the stock exchange. The book-building process is a very important part of the IPO. If they are not able to build their book in the best possible way, then it will be difficult for them to get listed on the stock exchange.
What Are Fixed Price Issues And Book Building Issues?
Once the valuation is done by the investment bank, the next step that comes is to decide what type of issue is to be brought. So there are two types of issues. One is the Fixed Price Issue, and another is the Book Building Issue.
Fixed Price Issue: Fixed price issues are those in which the share price of a company is fixed for a period of time. In a fixed price issue, the price is fixed and no bidding is done. There is a situation of taking it or leaving it. That is, the offer price is given, and people who want to invest can, and whoever doesn’t want to can leave it. So the demand is not properly assessed, which is why the book-building issue is highly recommended.
The issue will be listed on the stock exchange and traded as per the terms and conditions laid out by SEBI. This means that there will be no change in the share price during this period, unlike other issues where it is possible to see changes in its value depending on market forces.
Book Building Issue: Under the Book Building Issue, the price is not fixed, rather the price band is kept. The maximum amount is known as the “cap price,” and the minimum amount is known as the “floor price.” And people who are willing to invest and want to subscribe to that issue can place their bids. The maximum difference between the floor price and the cap price can only be 20%. Under this method, the risk of the issuer or underwriter is reduced because he is assessing the demand for how much investment will be kept at what price.
The most crucial reason why the book-building issue is recommended is that while making the decisions, the qualitative factors are also assessed. When a huge number of people bid on it, they will also analyze the qualitative factors, and collectively, market forces will also be an important factor in the pricing.
What are the Major Steps in Book Building?
In order to have a deeper understanding of Book Keeping, you need to learn about the steps involved in it.
- Appointment of Investment Banker: An investment banker is appointed by the company for the purpose of selling its shares in the public market. The appointment of an investment banker is a legal requirement under the Securities and Exchange Board of India (SEBI) rules. According to SEBI, it will be mandatory for all companies to appoint an independent investment banker before they can sell their shares in public markets. This means that when you are buying or selling your stock, there should be a third party involved who can help you with your transaction without any interference from the company itself.
- Filling Out Draft Draft Prospectus With SEBI: It is mandatory for every issuing company that is planning to issue shares in the market to prepare a draft and submit it to SEBI at least 21 days prior to filing the offer document with the Registrar of Companies (ROC) and Stock Exchange (SE).
Then SEBI is responsible for uploading the same prospectus on its official website and asking people to mention any errors they may find.
- Appointment of Syndicate Members: It refers to a group of individuals or companies that consists of brokers who are responsible for reaching out to the general public from different cities and states and convincing them to invest in your company.
Then we have underwriters whose job is to underwrite the issue to the extent of its “net offer to the public.”
- Request For Bids On The Price And Quantities Of Securities: Under this process, the syndicate members (brokers) will reach out to convince the general public to purchase the shares of the particular company by filling out the forms and asking questions about how many shares they would like to buy.
- Aggregate And Forward All Offers To The Book Runners:
The reason why this process is called Book-Building is that the company creates a digital book that consists of all the details of the applicants, including their name, phone number, PAN number, Demat Account number, Bank Account Number, the number of shares they want, and the price that they want to purchase the shares.
After the collection of the details from the investors, all brokers are responsible for delivering the pieces of information to the merchant bankers, also known as book-runners.
- Maintenance of the Subscriber and their order: This process includes the daily updating in the Digital Book of the new forms that the general public applies to purchase the security. The process runs until the issue is open. The general duration is 7 days.
- Determination Of Cut-Off Price: The most important thing is to decide the price of the share at which the shares will be allotted to the general public. That is the determination of the cut-off price. The cut-off price at which the shares will be allotted to the general public will be decided by the company’s closure along with the syndicated merchant bankers.
Allotment Of Securities To The Successful Bidders: The allotment of securities to the successful bidders will be made on the basis of their bids. The number and type of security allotted to the successful bidders will depend upon the value of their bids as determined by a committee appointed by the company. Companies reserve the right to increase or decrease the number, type, and/or value of securities allotted in any particular allotment round based on various factors, including but not limited to: (i) market conditions; (ii) the assessment that there are insufficient shares available for sale at a price equal to or less than their fair value; (iii) changes in their estimate of expected demand, etc.
Why Does SEBI Not Recommend Fixed Price Issues?
SEBI does not recommend fixed price issues because it is difficult to determine the fair value of securities. The prices of shares are determined by supply and demand. If there are a large number of investors who want to sell their shares at a particular price, then the price will fall due to this imbalance in supply and demand. This means that the market has already decided on what the fair value should be for that security, so if SEBI were to fix that price, then it would be setting itself up for failure.
Understanding The Timeline Of A Public Issue.
The timeline of a public issue is the time period in which a company has to disclose information about its financial performance. This period is also known as the “period of concern” or “period of interest,” and it usually lasts for four months, but can be extended if necessary. The disclosure must be made within this timeframe so that the investors know how well their investment will perform over the next few months.
Conclusion:
To understand how exactly an IPO works, you need to first acknowledge how the book building is done, what the steps are, and who the people involved in running the IPO successfully are. The collection of data, price determination, and finally share allotment is a complex process that requires time and effort. In this blog, we have tried to give you a firm understanding of all the necessary details that you need to figure out to understand the whole mechanism of the Book Building Process in IPOs. Keep reading for more such articles related to finance.
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