What is Book-building in IPO Pricing? 

Those investors exploring IPO investment should know about several aspects of an IPO’s working. Essentially, the book-building process of any IPO is a method that is employed for discovering an IPO price. Lead issuers and merchant banks commonly engage in this process. During the procedure of an IPO, an underwriter is involved in inviting prospective institutional investors and foreign portfolio managers, among other stakeholders, to offer bids for the potential IPO’s shares, setting the stage to determine the price of the IPO before offering it to the general public. 

What is book building? 

It is the underwriter who partakes in “building” the book after reviewing the average demand for shares from institutional investors. To arrive at a final price for shares offered by an IPO, a weighted average is considered and this is known as the “cut-off price”. 

In simple terms, the IPO price is decided by institutional investors, that is, whatever they are willing to pay for said shares in any given IPO. The bids are submitted by institutional investors. After this, their choices and allotment are provided to the public in the interest of transparency and validation of the arrived-at price of the IPO. This is the process that remains the cornerstone of pricing stock that is offered by an IPO, and the “book-building process”, as it is officially known, is mandated by major stock exchanges globally. 

What are the advantages of a book-building IPO? 

There are key benefits of a book-building IPO, an IPO that is structured on the process of book-building, and these are mentioned here: 

• Price Determination: The book-building process aids in deciding the share’s intrinsic value according to the demands set by investors. This is an effective strategy to determine the fair value of any stock of an IPO.
• Highest Stock Price: The book-building process aids companies floating IPOs to get the best possible (highest possible) price for their stock in the IPO. As investors attempt to give high bids, organisations are encouraged to increase the stock price.
• Access to Capital: IPOs issued through the book-building process aid companies achieve rapid access to funds and any capital they require.
• Pre-set Pricing: The value of an IPO that is based on the book-building process, is pre-determined in advance, before retail investors gain access to IPO subscription. Hence, this prevents any confusion related to the IPO price when it is introduced to investors.

What is the book-building process of an IPO?  

In terms of IPO pricing, the book-building process plays a key role, and this is one of the most important aspects of an IPO issue. The main steps involved in the book-building process are mentioned below:

1. An Underwriter is Hired: The first step in the book-building process of any IPO involves the hiring of an underwriter. This is commonly an investment bank whose purpose is to aid in deciding the IPO size. The underwriter also aids the company floating the IPO in deciding the price of the IPO (or the price range).
2. IPO Bidding: Once a price range is set by an underwriter, the company invites different institutional investors to offer bids for shares. These bids must be contained within the price band set forth by the underwriter. Then, investors will provide their bids according to the said price band.
3. IPO Price Determination: The underwriter has the responsibility of maintaining an order book to essentially record every bid that investors submit. Typically, underwriters depend on the method of weighted averages for determining the appropriate price of any IPO.
4. Allotment of Stock: After all the price bids are accepted, the price range of the IPO is fixed and then the IPO is issued to the general public for the allotment of shares. Investors from the general public can subscribe to an IPO for a certain number of shares they want, offering bids within the set band, and the company issuing the IPO has the prerogative of allotting these shares. 

Difference Between Fixed Pricing and Book-Building  

The price discovery process of any given IPO may follow one of two distinct procedures. These constitute the fixed price issue (fixed pricing) or the book-building issue (price determined by the book-building process). Although the book-building method offers transparency in pricing in an IPO, and is popular, investors should know about both kinds of offerings of IPOs. 

In an IPO involving a fixed price issue, the price of the stock is provided in the prospectus of the IPO. There is absolutely no method of average demand or bidding within any range for deciding the price of the IPO. While subscribing for the IPO, depending on the quantity of stock the investor wishes to buy, the full amount has to be paid. The demand for the IPO is disclosed after the end of the IPO. 

In the book-building method, the price of IPO stock is decided by a transparent procedure that includes the bidding of prices by investors, within a specific price band. Here, only the money for applying to the IPO must be paid by potential investors. This application fee must be paid at the time of bidding for the said IPO. The full amount is to be paid by the investor only when the price of the IPO is ascertained through the bidding process. 

The mechanism of fixed pricing in an IPO is limited to rights issues, follow-on issues, and ESOPs, but the initial public offering or IPO nearly always employs a book-building system. Furthermore, within the structure of fixed price IPO price determination, the company issuing the IPO could potentially be subject to substantial IPO pricing risks in case enough demand for the offering based on the price is not realised. The book-building issue of an IPO does away with such a risk. 

Conclusion 

The final verdict on IPO pricing veers towards the positivity and advantages of the book-building process that offers less risk and transparent pricing mechanisms. If investors get to know about this process of IPO pricing, they could likely increase their chances of positive gains from an IPO subscription. Nonetheless, this is not the only nuance of an IPO that investors should focus on while investing, although it is relevant. Depending on the investor’s risk appetite and financial goals, investors should research a company issuing an IPO and base decisions on the company’s financial standing, operational performance, and prospects for growth.