Book building is a process used by companies to determine the demand for their securities before the actual offering. It is a modern way of issuing securities that allows companies to efficiently raise capital while also setting an appropriate price for their securities. The book building process is widely used for public offerings of stocks, bonds, and other securities.
The basic concept of book building is to gather information from investors about their interest in buying the securities being offered. This information is then used to determine the demand for the securities, which in turn helps the company to set the final price of the securities. Book building is a very important process for companies because it allows them to understand the market’s appetite for their securities, which helps them to make informed decisions about pricing and other related matters.
Process of Book Building:
The book building process can be broadly divided into two stages:
- Pre-book building stage
- Book building stage
Pre-Book Building Stage:
In this stage, the company hires an investment banker, who acts as an underwriter for the offering. The investment banker helps the company to structure the offering and decides on the terms and conditions of the offering, such as the number of securities to be issued, the type of securities, the price range, the duration of the book building process, and the method of allotment.
The investment banker also conducts a thorough due diligence of the company, which includes analyzing its financial statements, its business model, its management team, and its market position. Based on this analysis, the investment banker prepares a detailed information memorandum, which is circulated to potential investors.
The information memorandum contains all the necessary information about the company, the securities being offered, and the terms of the offering. It also contains a risk disclosure statement, which highlights the risks associated with the investment. Potential investors can use this information to decide whether or not to participate in the book building process.
Book Building Stage:
In this stage, the investment banker invites potential investors to submit their bids for the securities being offered. The investors can either bid at the floor price or above the floor price. The floor price is the minimum price at which the company is willing to sell the securities. The investment banker also sets a cap price, which is the maximum price at which the securities can be sold.
The book building process typically lasts for a few days or weeks, depending on the size and complexity of the offering. During this period, the investment banker collects bids from investors and maintains a book of demand. The book of demand is a record of all the bids received from investors, along with the quantity and price of the bids.
Based on the bids received, the investment banker determines the demand for the securities and sets the final price of the securities. The final price is usually set at the highest price at which the securities can be sold to the investors who have bid for the securities. The investors who have bid at or above the final price are allotted the securities, and the remaining investors are refunded their money.
After the allotment of securities, the investment banker finalizes the allocation and notifies the investors of the allotment. The company then issues the securities to the investors, and the book building process is complete.
Advantages of Book Building:
- Efficient Pricing: The book building process helps companies to efficiently price their securities based on the demand from the investors. This helps to ensure that the securities are priced correctly, and the company is able to raise the required capital.
- Transparency: The book building process is transparent, and all investors have access to the same information about the securities being offered. This helps to create a level playing field for all investors, and reduces the chances of any insider trading or market manipulation.
- Wide Investor Base: The book building process allows companies to reach a wide investor base, including institutional investors such as mutual funds, pension funds, and hedge funds. This helps to increase the demand for the securities and ensures that the company is able to raise the required capital.
- Flexibility: The book building process is flexible, and allows companies to tailor the offering to meet the specific needs of the investors. For example, the company can offer different types of securities, such as equity shares, preference shares, or convertible bonds, depending on the demand from the investors.
- Speed: The book building process is faster than traditional methods of issuing securities, such as a fixed price offer or a public auction. This helps companies to raise capital quickly and efficiently.
Disadvantages of Book Building:
- Complexity: The book building process is complex and requires a high level of expertise and knowledge. This can make it difficult for small companies or companies with limited resources to participate in the book building process.
- High Costs: The book building process is expensive, as it involves hiring an investment banker, conducting due diligence, and preparing an information memorandum. This can make it prohibitively expensive for small companies or companies with limited resources to participate in the book building process.
- Lack of Control: The book building process gives investors a greater say in the pricing and allocation of the securities. This can reduce the company’s control over the pricing and allocation process, and may result in a lower price for the securities
Book Building example
Here’s an example of a book building process for an imaginary company, ABC Ltd:
- The company plans to issue 1 million equity shares through the book building process.
- The investment banker sets a floor price of Rs. 50 per share and a cap price of Rs. 70 per share.
- The book building process is open for 5 days, during which potential investors can submit their bids for the shares.
- At the end of the 5-day period, the investment banker receives bids from various investors, with the following details:
| Investor | Quantity Bid (in shares) | Bid Price (in Rs.) |
| Investor A | 200,000 | 65 |
| Investor B | 300,000 | 60 |
| Investor C | 150,000 | 55 |
| Investor D | 250,000 | 50 |
| Investor E | 100,000 | 70 |
| Investor F | 50,000 | 62 |
- The investment banker maintains a book of demand, which records the quantity and price of the bids received from each investor.
- Based on the bids received, the investment banker determines the demand for the shares and sets the final price at Rs. 60 per share.
- The shares are allotted to the investors who have bid at or above the final price, as follows:
- Investor A: 200,000 shares
- Investor B: 300,000 shares
- Investor C: 150,000 shares
- Investor D: 0 shares (bid below final price)
- Investor E: 100,000 shares
- Investor F: 0 shares (bid below final price)
- The remaining investors who bid below the final price are refunded their money.
- The company is able to raise Rs. 60 million through the book building process.