Table of Contents
Initial public offering (IPO) book building is a process to help determine the share price for an IPO.
With book building, the investment bank that underwrites an IPO reaches out to institutional investors to gauge their interest in buying shares of a company looking to go public. The underwriter asks those interested to submit bids detailing the number of shares they seek to own and at what price they would be willing to pay.
Read on to discover how book building works and how it can affect the price of an IPO.
Key Points
• Book building is the preferred method by which a company prices IPO shares.
• There are five key steps in the IPO book building process: find a banker, collect bids, determine a price, disclose details, and allotment.
• Partial book building is restricted to institutional investors, while accelerated book building is used for large equity offerings to raise capital in a short period.
• The risk of an IPO being underpriced or overpriced when shares go public can lead to volatility, making IPO investing a high-risk endeavor.
• The goal of book building is to ensure proper market-based price discovery to help the issuing company set a fair share price.
What Is Book Building?
Book building is the preferred method by which a company prices IPO shares. It is considered the most efficient way to set prices and is recommended by all the major stock exchanges.
Among the first steps of the IPO process is for the private company to hire an investment bank to lead the underwriting effort. IPO book building happens when the IPO underwriter gathers interest from institutional investors, such as fund managers and other large investors, to “build the book” of that feedback and determine the value of the private company’s shares.
As part of the IPO process, the investment bank must promote the company and the offering to stir up interest before they can determine share price.
This is typically called an IPO roadshow. If the underwriter finds that there is sufficient interest based on responses from the investor community, then the bank will determine an offering price.
Book building is common practice in most developed countries. It has become more popular than the fixed-pricing method, which involves setting an IPO price before measuring investor interest. Book building, on the other hand, generates and records investor interest to land on an IPO price.
Book building can help find a fair share price for a private company based on market interest. When a bank gauges market interest, a floor price is sometimes used, and bids arrive at or above that floor price. The stock price is determined after the bid closing date. With the book building method, demand can be seen in real-time as the book is being built.
💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.
Book-Building Process
Firms going public want to sell their stock at the highest possible price without deterring the investment community. There are five key steps the issuing company must perform in the process of IPO book building in order to discover a market-based share price.
1. Find a Banker: The issuing company hires an investment bank to underwrite the transaction. The underwriter advises the company, guiding it through the lengthy book-building process. The investment bank, as a firm commitment underwriter (the most common underwriting arrangement in an IPO), also commits to buying all the shares from the issuer, carrying all the risk. The bank will then resell the shares to investors.
2. Collect Bids: The investment bank invites investors to submit bids on the number of shares they are interested in and at what price. This solicitation and the preliminary bids give the bankers and the company’s management an indication of the market’s interest for the shares. Roadshows are often used to grow investor appetite.
3. Determine a Price: The book is built by aggregating demand as the bids arrive. The bank uses a weighted average to determine a final cutoff price based on indications of interest. This step helps with pricing an IPO.
4. Disclosure: The underwriter must disclose details of the bids to the public.
5. Allotment: Accepted bidders are allotted shares.
Even if the IPO book-building process goes smoothly and a price is set, it does not ensure that actual transactions will take place at that price once the IPO is open to buyers. Book building simply helps to gauge demand and determine a fair market-based price. But substantial risks remain for interested investors, who could see steep losses if the share price drops after the IPO.
💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.
What Is Partial Book Building?
Partial book building is another form of the IPO book-building process that happens only at the institutional level, rather than the retail level.
With partial book building, a select group of investors is approached regarding their interest in the IPO. Using their bids, a weighted average price is calculated and a cutoff price is determined. That cutoff price is then used as the public offering price to retail investors as a fixed price. The cost of the partial book-building IPO process is often lower due to its relative efficiency.
What Is Accelerated Book Building?
Accelerated book building is used for large equity offerings to raise capital in a short period of time. The investment bank is tasked with book building, determining a cutoff price, and allocating shares within 48 hours or less. No roadshow is involved.
The accelerated book-building process is typically used when a company needs immediate financing and raising capital from debt is off the table. It is typically done when a firm seeks to acquire another company.
Accelerated book building is often conducted overnight, with the issuing company asking investment banks to serve as underwriters before the next day’s placement.
What Effect Does Book Building Have On IPO Prices?
A good IPO book-building process helps ensure proper market-based price discovery. Still, there is the risk that an IPO can be underpriced or overpriced when shares finally go public. This can lead to volatility, which IPO investors also need to be aware of. This is one reason why IPOs are considered high-risk endeavors.
Underpricing happens when the offering price is below the share price on the first day of trading. In other words, the IPO is selling for less than its true market value. With an underpriced IPO, a company is said to have left money on the table because they could have set the offering price higher.
An overpriced IPO — meaning the offering price is above the stock’s true market value and higher than investors are willing to pay for it — can have negative implications for the future price of a stock due to poor investor response.
Investors may buy IPO stock on Day One of trading in the secondary market, while qualified investors can purchase IPO shares before they begin trading in the open market.
While there is no surefire way to guarantee a good IPO price, the book-building IPO method generally offers quality pre-market price discovery customized to the issuer. It also reduces the risk for the underwriter. It can have high costs, however, and there is the risk that the IPO will end up being underpriced or overpriced. The overall goal is to see a good and steady stock performance during and after the IPO.
The Takeaway
The book-building IPO process involves five critical steps to ensure a stock goes public promptly with as few hiccups as possible.
There are different types of IPO book building, and the way an investment bank performs the process can impact IPO prices. The goal is to set a fair market-based price for shares of the company looking to go public.
Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.
FAQ
What are the steps in book building?
There are five main steps in the book-building IPO process:
1. The issuing company hires an investment bank to underwrite the offering. The bank determines a share price value range and writes a prospectus to send to potential institutional investors.
2. The underwriting bank invites institutional investors to submit bids on how many shares they want to buy and at what price.
3. The book is built by sorting and summing up demand for the shares to calculate a final IPO price. It’s known as the cutoff price.
4. The investment bank is required to disclose the details of submitted bids to the public.
5. Shares are allocated to bidders who meet or exceed the final cutoff price.
What is 100% book building?
100% book building is when all of the company’s shares are sold through the book-building process. The final issue price of the shares is determined entirely by investor bids and demands.
Who carries out book building in an IPO?
The underwriters in an IPO, which are typically large investment banks, carry out the book building process. They build the book by asking institutional investors to submit bids for the number of shares of the company they’d be willing to buy and the price they would pay for the shares. They then list and evaluate investor demand based on the bids and use that information to set a price for the shares.
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