Every company that wishes to issue its shares to the public for the first time has to go through a process known as Initial Public Offering (IPO). There are two types of IPO that a company can opt for - a fixed-price IPO and a book-built IPO.
In a fixed-price IPO, the company sets a price at which the shares are to be issued to the investors. In a book-built IPO, however, the price discovery mechanism is entirely different. Except for SME companies, all other entities tend to choose the book-built IPO process.
Wondering what the book-building process in an IPO is and why companies tend to opt for it? Continue reading to find out.
What is the book-building process in an IPO?
The book-building process is a price discovery mechanism that’s used by companies issuing their shares to the public for the first time. Here, a company sets a price band with a lower and upper ceiling.
Investors desirous of subscribing to the public issue are encouraged to bid within this range. Once the issue closes, the company along with the Book Running Lead Managers (BRLMs) set the final cut-off price, using a weighted average method. The final cut-off price is the price at which the shares are issued to the investors.
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Here’s a hypothetical example of how the book-building process is done in an IPO.
Assume that a company wishes to issue 10,000 shares to the public via an IPO. It sets the price band for the issue as Rs. 500 to Rs. 550 per share. Interested investors can apply for the shares at any price within this Rs. 500 to Rs. 550 range. Here’s a hypothetical representation of the investors’ bids.
Investor
|
No. of Shares Applied |
Bid Price |
Investor 1 |
1,000 |
Rs. 510 |
Investor 2 |
2,000 |
Rs. 520 |
Investor 3 |
3,000 |
Rs. 530 |
Investor 4 |
3,000 |
Rs. 540 |
Investor 5 |
2,000 |
Rs. 540 |
Investor 6 |
4,000 |
Rs. 550 |
Investor 7 |
5,000 |
Rs. 550 |
Total |
20,000 |
|
The company then calculates the weighted average price of all the bids received by it and sets the final cut-off price. Investors who bid on or above the final cut-off price will be allotted the company’s shares. And investors who bid lower than the final cut-off price will not be allotted any shares. Any amount blocked on their account on account of the IPO will be released.
Why do companies opt for the book-building process?
There are many reasons why companies tend to opt for a book-built IPO. Here’s a quick look at a few of them.
1. Efficiency
Since the issue price is determined by analyzing the demand for the IPO, a book-built IPO is far more efficient than fixed-price issues.
2. Accuracy
When a company sets the IPO price, the chances of it being undervalued or overvalued are high. However, by opting for the book-building process, the company can arrive at a price that’s likely to be closer to its real intrinsic value.
3. Transparency
In a fixed-price IPO, the pricing methodology adopted by the company is not disclosed. The book-building process, on the other hand, is very transparent with the company disclosing the bidding information to the public.
4. Lower Costs
In a fixed-price IPO, the company has to come up with the IPO price through extensive calculations and deliberations. These extra steps can increase the cost of the public issue significantly. By opting for the book-building process, a company can leave the price discovery process to the market forces, which reduces the overall costs incurred by the company.
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What does the SEBI have to say about the book-building process?
According to the guidelines issued by the Securities Exchange Board of India, a company can choose to opt for a 100% book-built IPO or a 75% book-built IPO. In a 100% book-built IPO, the pricing for the entire issue is discovered through the book-building process.
Similarly, in a 75% book-built IPO, pricing for only 75% of the issue is discovered through the book-building process. The pricing for the remaining 25% of the issue can be fixed by the company after determining the issue price through the book-building process. Discover the latest updates and insights on the Upcoming IPOs 2023!
Conclusion
With this, you must now be aware of what the book-building process in an IPO is. The next time you subscribe for a book-built IPO issue, make sure to tick the ‘cut-off price’ option in the IPO application. This will ensure that your bids are placed at the cut-off price, whatever it may be, thereby increasing the chances of allotment.
Now, to invest in an upcoming IPO, you would need to have a trading and demat account in your name. If you don’t have one, you can simply visit the website of Motilal Oswal and submit an online application to open a demat account and a trading account. The entire process is paperless and can be completed from the comfort of your own home.
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