When a company decides to go public through an Initial Public Offering (IPO), it needs to determine the right price for its shares. In the past, companies used a fixed price method where shares were sold at a predetermined rate. Today, the standard method regulated by SEBI, NSE, and BSE is known as โbook buildingโ. This mechanism allows the market to discover the fair value of a company based on actual demand from investors.
What is Book Building?
Book building is the process by which an issuing company attempts to determine the price of its IPO shares based on the demand from institutional, non-institutional, and retail investors. Instead of fixing a single price upfront, the company, in consultation with its merchant bankers, announces a price band with a floor price and a cap price. Investors then bid for shares within this range, and the final price is determined based on the bids received.
The Step-by-Step Book Building Process
Understanding the timeline helps retail investors navigate an IPO smoothly. The process typically follows a structured sequence:
- Price Band Announcement: The company sets a price band, where the cap price cannot exceed 120 percent of the floor price.
- Bidding Window: The IPO opens for bidding, usually lasting a few working days. During this time, investors submit their bids through their brokers or UPI-enabled applications.
- Bid Revision: Investors generally have the option to revise or cancel their bids while the window is open.
- Price Discovery: At the close of the bidding period, the book is built. The final issue price is determined at the cut-off where demand equals the supply of shares.
- Basis of Allotment (T+1 to T+3 timeline): Shares are allotted to successful bidders, and refunds are processed for unallotted applications within the mandated regulatory timeline.
Worked Example: Illustrative Book Building
To understand how the final price is discovered, consider the following hypothetical and illustrative example. Assume a company wants to raise capital by issuing 1,000,000 shares. It sets a price band with a floor of INR 100 and a cap of INR 120.
| Bid Price (INR) | Demand at Price (Shares) | Cumulative Demand (Shares) |
|---|---|---|
| 120 | 300,000 | 300,000 |
| 115 | 400,000 | 700,000 |
| 110 | 400,000 | 1,100,000 |
| 105 | 200,000 | 1,300,000 |
| 100 | 100,000 | 1,400,000 |
In this illustrative scenario, cumulative demand reaches 1,100,000 shares at a price of INR 110, which is enough to cover the entire issue size of 1,000,000 shares. Therefore, the final issue price is discovered at INR 110. All investors who bid at INR 110 and above receive shares at this final discovered price, while bids below INR 110 are unsuccessful.
The Retail Investor and the โCut-Offโ Option
As a retail investor bidding within a specific financial limit, you have the option to check the โcut-offโ box on your application. By selecting cut-off, you agree to buy the shares at whatever final price is discovered through the book building process. This ensures that your application remains valid even if the final price settles higher than your initial guess, protecting you from missing out due to pricing mismatches.
Common Mistakes to Avoid
Book building requires careful participation. Retail investors should avoid these frequent errors:
- Bidding Below the Floor Price: Any bid placed below the floor price is instantly rejected by the exchange system. Always check the official price band.
- Multiple Bids from the Same Account: Submitting multiple applications using the same PAN can lead to the rejection of all applications by the registrar.
- Ignoring Mandate Approval: For UPI-based applications, failing to accept the payment mandate in your banking app before the deadline results in an invalid bid.
- ่ฟฝใ-chasing Hype: Making decisions based on unverified market chatter rather than studying the draft red herring prospectus (DRHP) and company fundamentals.
Frequently Asked Questions
What happens if an IPO is under-subscribed?
If total demand fails to reach the minimum subscription threshold mandated by SEBI (usually 90 percent of the net offer), the issue cannot proceed, and all application money must be refunded to investors.
Can the price band be changed during the bidding period?
Yes, the issuer can revise the price band. If the band is revised, the bidding period must be extended by at least a few additional working days to give investors adequate time to react to the new range.
Where are IPO bids processed?
Bids are routed through registered intermediaries and processed electronically on the trading platforms provided by stock exchanges like NSE and BSE, ensuring transparency and fair allocation under SEBI guidelines.
SEBI Compliance & Statutory Disclaimer: this guide is for education only and is not investment advice. IPO Bulletin is not a SEBI-registered investment adviser. Rules referred to are set by SEBI, NSE and BSE; check the latest circulars before you apply.
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