due_logo
Search
Close this search box.

Table of Contents

Book Building

Definition

Book building is a process used by companies raising capital to gauge and compile investor demand for a public offering of securities. During the book building, the underwriter records investor demand for shares at various price points from the floor price up to the cap price. The final issue price is determined after the book building process, based on investor feedback.

Phonetic

The phonetics for the keyword “Book Building” is: /bʊk ˈbɪldɪŋ/

Key Takeaways

<ol><li> Book building is an innovative process employed during an Initial Public Offering (IPO) where an underwriter accepts bids for shares, thus determining the final issue price. This is different from traditional methods of setting a fixed price for the shares.</li><li> The process involves a two-way communication as the price of the shares is determined by the demand from institutional and retail investors. Investors submit their bids, specifying the number of shares and the price they are willing to pay. This process can help in better price discovery.</li><li>Book building is beneficial for both the issuer and the investor. For the issuer, it helps in realizing the true value and demand for the company’s shares. For investors, it offers an opportunity to place bids according to their perception of the company’s worth.</li></ol>

Importance

Book Building is an important concept in business and finance as it’s the process that underwriters use to determine the price at which an initial public offering (IPO) will be offered. It’s a systematic process of generating, capturing, and recording investor demand for shares during an IPO (or other securities during their issuance process) to support efficient price discovery. It provides invaluable market insights about the demand for securities and the price investors are willing to pay, which greatly aids in setting the fair and accurate price of an IPO. This process maximizes capital generation for firms, ensures equitable share allocation among investors, and reduces the chances of price volatility post issuance. Hence, Book Building plays a critical role in capital market transactions, striking a balance between the interests of issuing company and potential investors.

Explanation

Book building is a contemporary method used by companies for raising capital through the public. The primary purpose of book building is to discover the ideal price of securities being offered based on investors’ demand. It works on the principle of demand-supply, where the quantity of securities demanded and the price that investors are prepared to pay influences the security’s issue price. This process provides the issuer an insight on investor demand and allows them to adjust pricing or quantities accordingly. It offers a competitive and transparent process to companies and underwriting firms to analyse the price at which stocks can be sold based on an understanding of the capital market.Book building is primarily useful when there is uncertainty about the price that will be paid for a financial instrument. It aids underwriters, or book runners, to gauge the investor demand for securities and then estimate a reasonable price range, thus mitigating the risk of overpricing or underpricing. Not only does this system serve to generate demand, but it also aims to help market the issue efficiently. Essentially, book building serves as a critical tool in capital market transactions and is utilized for maximizing the success of a public offering by assisting in the determination of the best issue price.

Examples

1. Google’s Initial Public Offering (IPO) – 2004:When Google decided to go public, it chose book building through a Dutch auction. This allowed the company to sell its shares to the highest bidders, which were very widely distributed. The IPO was managed by Credit Suisse Group and Morgan Stanley, and Google’s shares were initially priced between $108 and $135. These numbers were based on what institutional investors stated they were willing to pay per share during the book-building process.2. Facebook’s Initial Public Offering (IPO) – 2012: Facebook used the traditional book building process for its IPO. The IPO was one of the biggest in technology and Internet history, with a peak market capitalization of over $104 billion. Morgan Stanley, together with other underwriters, helped price the shares through a process of collecting indications of interest from institutional investors (with the price eventually set at $38 per share).3. Reliance Power’s Initial Public Offering – 2008:In India, the largest IPO up to that time was Reliance Power, which raised $3 billion. The book runners were Deutsche Bank, ICICI Securities, JM Financial, UBS Securities, and Kotak Mahindra Capital. The price band for the offer was decided through book building process with a range between Rs 405 to Rs 450. The IPO was a success with a significant over-subscription. Remember, in the book building process, the price of the security offered is determined based on the bids and the quantity demanded by the investors once the bid is closed.

Frequently Asked Questions(FAQ)

What is Book Building?

Book Building is a process by which an underwriter attempts to determine at what price to offer a securities issue based on demand from institutional investors.

Who are the main participants in the Book Building process?

The main participants in a Book Building process are the issuing company, the book runner (usually an investment bank), and institutional investors.

What is the primary purpose of Book Building?

The primary purpose of Book Building is to discover the price at which an offering is most likely to be successful, i.e., the price at which demand from investors is strongest.

How is the Book Building process different from a traditional auction?

Book Building is a largely private process, involving the negotiation of price amongst institutional investors and the underwriters. In contrast, an auction is a largely public process where price is based on bidding amongst participants.

How does Book Building affect the price determination of securities?

Book Building helps in the accurate pricing of securities. It does so by exploring the demand and the price institutional investors are willing to pay, ensuring the issued price reflects the true value the market assigns to the security.

What is the role of the book runner in the Book Building process?

The book runner, usually an investment bank, is in charge of keeping a record of the bidding process, which includes the number of shares bid for and at what price.

Is Book Building only used for Initial Public Offerings (IPOs)?

While Book Building is most commonly associated with IPOs, it may also be used in other scenarios such as private placements or debt issues.

Can retail investors participate in the Book Building process?

Typically, Book Building is geared towards institutional investors. However, in some jurisdictions and scenarios, retail investors may also be allowed to participate.

Does Book Building guarantee the success of the issue?

Book Building does not guarantee the success of the securities issue, but it aids substantially in price discovery, reducing the chances of the issue being overpriced or underpriced.

How long does the Book Building process usually take?

The duration of the Book Building process can vary greatly and depends on a range of factors, including the size and complexity of the issue, market conditions, among others. It could take anywhere from a few weeks to a few months.

Related Finance Terms

  • Initial Public Offering (IPO): A process through which a private company goes public by selling its stocks to the general public for the first time.
  • Underwriting: The process where investment banks buy or promise to buy shares during public offering and then sell to the public.
  • Red Herring Prospectus: A document submitted by a company as part of a public offering or an IPO that contains details about the business operations, financials, and risks associated with the investment.
  • Issue Price: The price per share at which a company’s shares are initially sold to the public during an IPO.
  • Bid: The willingness of a potential investor to buy a certain number of shares at a particular price during the book building process.

Sources for More Information

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More