Book Building: Meaning and Benefits | Financial Management

In this article we will discuss about:- 1. Meaning of Book Building 2. Benefits of Book Building 3. Limitations of Book Building.

Meaning of Book Building:

Book building is a process of price discovery. Book building is a process by which the issuer company before filing of the prospectus, builds-up and ascertains the demand for the securities being issued and assesses the price at which such securities may be issued and ultimately determines the quantum of securities to be issued.

Under book building process, the issuing company is required to tie up the issue amount by way of private placement. The issue price is not priced in advance. It is determined by offer of potential investors about price which they may be willing to pay for the issue. To tie-up the issue amount, the company organizes road shows and various advertisement campaigns.

During book building process, the issuer company ties up with a selected group of individuals and agencies for private placement. The entire exercise is done on a whole sale basis.

The issuing company appoints a lead manager who builds the order book by forming a syndicate of eligible potential buyers. The book runner (lead manager) notes the amounts offered by various investors such as Institutional Investors, Mutual Funds, Underwriters, Foreign Institutional Investors etc.

The price of the instrument is the weighted average at which the majority of investors are willing to buy the instrument. The price is investor driven and based on market forces of demand and supply. Book building refers to the collection of bids from investors, which is based on an indicative price range, the offer price being fixed after the bid closing date.

The principal parties/intermediaries involved in a book building process are:

(a) The Company.

(b) A Book Running Lead Manager who is a category I Merchant Banker registered with SEBI. The book running lead manager is also the lead merchant banker.

(c) Syndicate members who are intermediaries registered with SEBI and who are permitted to carry on activities as underwriters. Syndicate members are appointed by the book running lead manager.

Benefits of Book Building:

Book building helps in evaluating the intrinsic worth of the instrument being offered and the company’s credibility in the eyes of public. The entire exercise is done on a wholesale basis.

(a) Price of instrument is determined in a more realistic way on the commitments made by the prospective investors to the issue.

(b) The prime objective of book building process is to determine the highest market price for shares and securities and demand level from highest quality investors in order to adjust pricing and allocation decision.

(c) Book building is a process of fixing price for an issue on feedback from potential investors on how they are willing to bid to pick up issues and instruments.

(d) The process of book building is advantageous to the issuer company as the pricing of issue would be more realistic as the final price is decided about 11 to 12 days before the opening of the issue. Book building also offers access to capital more quickly than the public issue.

(e) As the issue is pre-sold, there would be no uncertainties relating to the fate of the issue involved.

(f) The Issuer company saves advertising and brokerage commissions.

(g) Issuers can choose investors by quality.

(h) Investors have a voice in the pricing of issues. They have a greater certainty of being allotted what they demand. Investors need not lockup huge amounts of capital with the Issuer as they pay at the end of the process.

(i) The issue price is market-determined. As it is a distant possibility that the market price of the shares would fall lower than the issue price. Hence, the investor is less likely to suffer from erosion of his investment on listing.

(j) Optimal demand based pricing is possible.

(k) Efficient capital raising with improved issue procedures, leading to a reduction in issue costs, paper work and lead times.

(l) Flexibility to increase/decrease price and/or size of offering the issues is possible.

(m) Transparency of allocations is made.

(n) Upgraded information flow of issues, lead managers, syndicate members and investors is made possible.

(o) Book-building process inspires investors confidence leading to a larger investor universe.

(p) Book-building process creates a liquid and buoyant after market.

(q) As the syndicate members will get firm allocation, the investors to that extent are assured of allotment.

(r) Immediate allotment and listing of placement portion of securities.

Limitations of Book Building:

The book-building system has various limitations, some of these limitations are summarized as follows:

1. Book building is appropriate for mega issues only. In the case of small issues, the companies can adjust the attributes of the offer according to the preferences of the potential investors. It may not be possible in big issues, since the risk-return preference of the investors cannot be estimated easily.

2. The issuer company should be fundamentally strong and well known to the investors.

3. The book building system works very efficiently in matured market conditions. In such circumstances, the investors are aware of various parameters affecting the market price of the securities. But, such conditions are not commonly found in practice.

4. There is a possibility of price rigging on listing as promoters may try to bailout syndicate members.