Initial public offering (IPO) book building can help with efficient price discovery for companies looking to IPO. After the IPO, when shares are available for trading in the secondary market, book building may also be used to price secondary equity offerings.
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.
What Is Book Building?
Book building is the preferred method by which a company prices IPO shares. 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 determine the value of the private company’s shares.
As part of the book-building process, the investment bank must promote the company and the offering to stir up interest before they can determine share price. This is often 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 to the issuer.
Book building is recommended by all the major stock exchanges and 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 helps 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.
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 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 determines a fair market-based price.
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 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.
Underpricing, the main risk to the issuer, happens when the offering price is materially below the share price on the first day of trading. With an underpriced IPO, a company is said to have left money on the table, while an overpriced IPO can have negative implications on the future price of a stock due to poor investor sentiment. Investors can 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 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. The overall goal is to see a good and steady stock performance during and after the IPO.
Invest in IPOs Today With SoFi
The book-building IPO process involves many 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 for efficient price discovery on shares of the company looking to go public. Book building can also be used for secondary equity offerings.
Interested in IPOs? You can trade IPO stocks with SoFi Invest®. SoFi offers an IPO investing center where qualified investors can get allocated IPO shares before they start trading on the secondary market.
What are the steps in book building?
There are 5 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 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 accepted bidders.
What is 100% book building?
100% book building is a process in which 100% of the offering is done on a firm basis or is reserved for promoters and permanent employees of the issuing company. There are several qualifications outlined by the Securities and Exchange Board of India (SEBI) .
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Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.
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