Learn about book building - the crucial process which underwriters use to ascertain the price at which an Initial Public Offering (IPO) should be offered, along with the steps involved in this process.
- Book building is the process by which an underwriter attempts to determine the price at which an initial public offering (IPO) will be offered.
- The process of price discovery involves generating and recording investor demand for shares before arriving at an issue price.
- Book building is the de facto mechanism by which companies price their IPOs and is highly recommended by all the major stock exchanges as the most efficient way to price securities.
The book-building process comprises these steps:
- The issuing company hires an investment bank to act as an underwriter who is tasked with determining the price range the security can be sold for and drafting a prospectus to send out to the institutional investing community.
- The investment bank invites investors, normally large-scale buyers and fund managers, to submit bids on the number of shares that they are interested in buying and the prices that they would be willing to pay.
- The book is 'built' by listing and evaluating the aggregated demand for the issue from the submitted bids. The underwriter analyzes the information and uses a weighted average to arrive at the final price for the security, which is termed the cutoff price.
- The underwriter has to, for the sake of transparency, publicize the details of all the bids that were submitted.
- Shares are allocated to the accepted bidders.
Even if the information collected during the book building process suggests a particular price point is best, that does not guarantee a large number of actual purchases once the IPO is open to buyers. Also, it is not a requirement that the IPO be offered at that price suggested during the analysis.