- Summary
- Book building is a demand-based IPO pricing method in which investors submit bids within a specified price band, with the final issue price determined after the bidding period.
- In a fixed-price offer, the issue price is announced before the offer opens and investors apply at that predetermined price.
- The pricing method alone does not determine the quality of an IPO, so investors should also assess the company and offer details.
The use of book building and fixed price offerings is a popular strategy adopted by corporations to determine and sell the prices of their shares through an initial public offering (IPO). The Book-building strategy was introduced by SEBI in 1995. Under it, the bidders place their bids for the shares within the specified price band, and the price of issuance of the shares is determined based on the bids received.
The fixed price strategy involves the corporation determining a single price of shares to be sold before the opening of the offer. The investor then applies for the shares at the determined price. The choice of the two methods is dependent on the strategy to be employed in the determination of share price. Investors need to analyze the underlying fundamentals of the companies rather than relying on IPO strategies.
What is Book Building?
The book-building approach is a method of price discovery used during the IPO stage. It involves the company, together with the lead manager, announcing the price range that consists of the lowest and highest prices for the shares.
The investors will then be able to place bids for the number of shares and the price they are willing to pay within the announced price range. The demand for the stock at various prices will be taken into account when determining the issue price, also referred to as the cut-off price. Institutional, high-net-worth, and retail investors can be involved, depending on the IPO guidelines.
What is a Fixed Price Offer?
A fixed-price offer is an IPO pricing method in which the issue price is determined before the offer opens. Investors therefore know the price at which they can apply for shares from the beginning.
Unlike book building, investors do not select a bid price within a price band. They apply at the predetermined issue price. Investor demand becomes known after the issue closes, whereas demand in a book-built issue can be tracked during the bidding period.
Book Building vs Fixed Price Offer
Book building and fixed-price offers differ mainly in how the IPO share price is determined and how investors participate.
| Basis | Book building | Fixed price offer |
| Meaning | Investors bid within a specified price band | Investors apply at one predetermined price |
| Issue price | Final price is determined after the bidding process | Issue price is determined before the offer opens |
| Price selection | Investors can submit bids within the permitted price band | Investors apply at the fixed issue price |
| Demand visibility | Demand can be tracked during the bidding period | Demand is known after the issue closes |
Investor-Category Reservation
IPO shares may be divided among different investor categories based on the applicable issue structure and SEBI rules. In a book-built issue, portions of the net offer may be allocated to categories such as QIBs, NIIs and RIIs.
Separate reservation portions may also be available for eligible categories such as employees or shareholders, where applicable. The exact allocation and reservation structure is disclosed in the offer document.
How Book Building IPO Works vs Fixed Price IPO
A book-building IPO involves announcing a price range and initiating the bidding process. Applications are submitted by investors within the announced price range, and bids indicate demand.
Based on demand and other considerations, the company decides the issue price once the issue period ends. In a fixed-price IPO, only one price is announced by the company, and applications are placed at that price. The demand can be ascertained only after the issue period closes.
Key Differences, Advantages & Limitations
Book building has some advantages due to its demand-driven pricing of shares, although there are also disadvantages investors need to know about.
Book Building Advantages
- Price Discovery: This method enables determination of the price by assessing demand at various price levels. This may help determine how much investors are willing to pay.
- More Price Flexibility: Bids can be made within the provided price range, rather than on a single specific price. This means the company will receive bids at various price levels. Information from this exercise can be used in determining an appropriate final issue price.
- Assists in Estimating Interest from Investors: This technique provides information regarding demand even before the issue price has been determined. The company and underwriters can then analyze interest shown by different categories of investors. Thus, the price determination process becomes much more informed.
Book Building Disadvantages
- May Cause Some Challenges for New Investors: New investors may have trouble understanding the concepts of price bands, bidding, and cut-off prices. They will have to learn about bidding procedures before making their bids.
- Final Price is Unknown at First: Investors are aware of the price range but do not know the final price of the issue until bidding takes place. This means the price remains unknown during the application period. The investors have to be well-versed in the pricing process.
- Subscribed IPOs Do Not Mean Success: A successful IPO subscription does not necessarily imply success in terms of listing performance or returns. Share prices will vary depending on prevailing market conditions and the firm’s performance.
While a fixed-price offer is easy in that the company sets a single share price, there are some shortcomings of the method related to price discovery and market demand.
Fixed Price Advantages:
- Known Price of Shares: The price of the shares is known beforehand. There is no price range, and the bidding process is not involved. It becomes easy for the investor to calculate the amount of money needed for investment.
- Application Process Becomes Easier: Applying for the shares is easier because there is only one price. There is no need to decide the price at which the investor will bid for shares from a range of prices. It can be an advantage for first-time investors.
Fixed Price Disadvantages:
- Market Demand Not Very Considered: The price of issue will be fixed before the IPO opens and will not be determined by bids at various price levels. In this case, the predetermined price will not fully capture the market demand. Market conditions may also change during the subscription period.
- Less Pricing Flexibility: Investors apply at the predetermined price set by the company, unlike in book-building, where a price band enables bidding at various price levels. Thus, the price discovery process in this case becomes less flexible.
- The Market Demand is Known Later: The level of market demand will only be known after the subscription period closes. The company will not receive price-level demand information from the issue, as in the case of book-building.
Final Thoughts:
There are two methods by which firms can determine the price of their shares in an IPO: book-building and fixed-price offers. Book-building uses investors bids within a price range to determine the share price, while a fixed-price offer sets a single issue price for shares.
There are certain strengths and weaknesses with each of the two methods, and therefore investors need to familiarise themselves with the pricing method being adopted by the firm before applying for an IPO.
FAQs
Yes, the book-building process is based on demand. Bids are placed within the price band indicated by the firm. The bids received at various prices help in determining the final issue price.
Yes, a book-building IPO involves using a price band rather than a single price. Investors have an opportunity to bid within the price band. The final issue price is determined after considering the bids received.
No, the final price of the IPO is determined only after the bid is completed. The price band is known to the investors, but the final price is not known initially. The final price depends on the demand created in the book-building process.
No, there is no bidding system for fixed-price IPOs. In the case of a fixed price, only one price is announced by the firm. The application for the shares is made at the fixed price.
Yes, fixed-price IPOs are simpler for beginners since the stock price is preset. There is no need to bid on the price range, and the application process is quite simple.
Yes. The pricing method depends on the structure of the particular issue and applicable regulations. SME IPO frameworks can accommodate both book-building and fixed-price issues.
Yes, retail investors can take part in both book-building and fixed-price IPOs depending on the requirements of the particular IPO. The procedure of reservation and allocation may differ from one offering to another. One needs to study IPO documents carefully.
Yes, book building gives an idea about investor interest in terms of bids submitted at different price levels. This is useful for setting the final price, but the high demand at IPO does not always ensure successful performance of stocks.
