Book building process in an IPO- Definition, Process & Steps involved

2022 was a very eventful year for the stock markets as many IPOs were launched right until the last week of December. IPOs present excellent opportunities especially for retail investors to be part of companies that have a good financial performance and seek capital for various purposes like an expansion of business, meeting the minimum public contribution, purchasing or setting up of new manufacturing facility, etc. Among these IPOs, the majority were in the nature of a book-built IPO. The meaning and related details what is book building process in an IPO. 

Read More: Mistakes to avoid while investing in IPOs

What is the meaning of book building in IPO?

Book-built IPO is a process of price discovery in an IPO rather than fixing the price for an IPO as in the case of a fixed-price IPO. The issuer (company issuing shares) determines the price band for the shares to be subscribed under the IPO in consultation with the underwriters and the lead managers of the IPO. The price band has a floor price and a cap price within which investors have to place their bids for the lots of shares at their discretion. The issue price for the IPO is determined based on the demand for the shares from each investor category eligible to participate in the IPO. 

What are the steps in the book building process?

The book-building process is quite lengthy but very simple. It involves the participation of various stakeholders of the IPO working in perfect coordination. The steps involved in the book-building process are given hereunder.

Appointment of underwriter

In a book-built initial public offering (IPO), an underwriter is appointed to act as an intermediary between the issuing company and potential investors. The underwriters are responsible for the successful completion of the IPO without any hassles. The issuer usually selects the underwriter through a competitive bidding process, taking into account factors such as the underwriter’s reputation, experience, and track record. The range of responsibilities of an underwriter includes 

• The underwriters are required to commit to purchasing any shares that are undersubscribed in the IPO
• They work with the issuing company to set the price band for the shares and determine the final issue price based on the orders received to gauge demand.
• The underwriters are also responsible for distributing the shares to potential investors by part of the team leading roadshows and taking orders for shares.
• They are further responsible for efficient risk management for the risk associated with the IPO. This includes ensuring the optimum pricing of shares and ensuring there is sufficient demand for the same.
• It is also the responsibility of the underwriter for ensuring that the IPO complies with all prevailing laws and regulations.
• Finally, they are also charged with ensuring the listing of shares on the stock exchanges.

Bidding by the investors

The bidding process by investors is the next step in the book-built IPO. Investors review the prospectus of the company and decide whether they want to bid for the IPO and the number of lots that they want to bid for in the IPO. The bidding is open for the IPO period which is usually 3 to 5 days. During this period, investors are required to bid for their target lots of shares within the price band. The price band can be different for different categories of investors at the discretion of the issuer and the underwriters. Retail investors’ bids are usually at the cut-off price to ensure allotment.

Determining the prices for the shares

The price of the shares is determined through a process called building the book. During this process, interested investors submit bids for the number of shares they want to purchase at a certain price. The company and its underwriters then compile the bids in each category of investors and use that information to set the final price for the shares. The final price is usually the highest price at which a sufficient number of shares can be sold to the public. The final price is also known as the cut-off price and is usually announced after the book building process is complete.

SEBI guidelines for the book building process

Transparency is a crucial aspect of the book building process. SEBI has implemented several measures to ensure transparency during the book building process. Some of these measures include:

• The issuer has to disclose the issue size and the number of shares available for bidding to the public.
• Bids are then allowed to be placed at different price points.
• Underwriters and issuer have to provide regular updates on the number of shares bid for as well as the prices at which they were bid for.
• Investors are also allowed to alter or withdraw their bids at any time before the IPO is closed.
• All information related to the book building process is made available on the stock exchange’s website.
• Finally, the information on the cut-off price and the allocated shares to each category of investors, in the end, is released.

These measures are put in place to ensure that the book building process is fair and transparent and that the final price of the shares reflects the true demand for them.

Allotment and settlement process

Once the final price is determined, the shares will be allotted to successful bidders. In the case of oversubscription, allotment is usually done on a proportionate basis, according to the number of shares bid for and the price at which they were bid for. Investors who are not allotted any shares in the IPO receive a refund of the money they had paid as a bid amount. The shares of the company are then listed on the stock exchange making them available for trading by the public. As per SEBI, the settlement process for the shares is done on a T+2 basis, which implies that the shares are settled two days after the trade date. Investors who have received an allotment of shares will get the credit of such shares in their Demat account on the settlement date.

What are the pros and cons of the book building process?

The book building process has both advantages and disadvantages. The details of the same are mentioned hereunder.

Advantages of the Book building process

Some of the pros include:

• Price discovery

Pricing of securities in the book building process based on the bids received from investors. This allows the company and its underwriters to determine the true demand for the shares which is instrumental in setting a fair and accurate price for the shares.

• Flexibility

Investors can bid for shares at different price points, which provides them with more flexibility in terms of how much they are willing to pay for the shares.

• Transparency

The book-building process is more transparent as investors get all the details related to the prices, volume, and cut-off price. This process also allows them to withdraw or modify their bids.

Disadvantages of the Book building process

On the other hand, some of the cons of the book building process include,

• Complexity

The book building process can be complex and time-consuming. This may deter many investors from taking part in the IPO. 

• Risk of underpricing

There is a risk of underpricing of shares if the demand is not accurately reflected in the book building process.

• High cost of operations

This process is costlier than fixed price IPO which can be unfavourable for some issuers. 

Conclusion

Book building IPO although lengthy and costlier than the fixed price is still considered to be more efficient and acceptable than the fixed price IPO. This process allows price discovery directly through the participation of investors allowing the issuer to gauge the response to the IPO. Therefore, although this type of IPO is relatively new in the Indian market, it is fast becoming the popular choice for issuers and investors alike.

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