The process of determining the price at which a company’s shares will be offered to the public during an Initial Public Offering (IPO) is a critical & complex undertaking. IPO pricing involves a delicate balance of factors, Including market conditions, investor demand, and the company’s financial health. In this introduction, We will delve into the intricacies of IPO pricing, Exploring the strategies & considerations that companies must navigate for a successful market debut.
IPO Pricing Methods
IPO pricing methods are diverse and multifaceted, tailored to meet a company’s specific circumstances and objectives. Some common approaches include the Book Building Method, Fixed Price Method, and Dutch Auction Method. Each method has its unique features, advantages, and potential drawbacks, making it essential for companies to carefully select the most appropriate pricing strategy to ensure a successful and lucrative initial public offering.
Book Building Method
The Book Building Method is an IPO pricing approach where the issuer, in collaboration with underwriters, assesses investor demand to determine the offering price. In this process, potential investors submit their bids and the price they are willing to pay. The offering price is then determined based on the collected bids, aiming to strike a balance between investor interest and the issuer’s fundraising goals. This method is flexible and can help optimize pricing in response to market dynamics.
Book Building Advantages
The book-building method offers the following advantages to the company:
- An efficient mechanism for price discovery.
- The company can assess its credibility based on the demand for the issue.
- A realistic approach to pricing that is based on demand for the shares and not set by management.
Book building Disadvantages
Book building has certain limitations, which are listed below:
- Costly compared to a fixed issue IPO.
- Lengthy process for issuing shares as the price has to be calculated at the end of the bidding process.
- Suitable for large issuance volumes.
Book Building Features
Dynamic Pricing: The final offer price is not predetermined. Instead, it is determined through the bidding process, allowing it to fluctuate based on investor demand.
Price Discovery: The method enables price discovery through the aggregation of investor bids. The final price reflects what investors are willing to pay, indicating market sentiment.
Tailored Pricing: The issuer can adapt the price range based on the demand received during the book building process, maximizing the potential for a successful offering.
Transparency: Investors can see the price range and adjust their bids accordingly, enhancing transparency and fostering fair market participation.
Optimized Fundraising: By setting the price within the range where demand is strongest, the company can raise capital more efficiently and reduce the risk of underpricing or overpricing its shares.
Book building process explained
Appointment of Lead Managers and Underwriters: The company planning to go public appoints lead managers and underwriters, who are responsible for managing the IPO and the book-building process.
Determination of Price Range: The lead managers and the issuer decide on a price range within which shares will be offered to the public. This range is not a fixed price but a bracket indicating the minimum and maximum prices.
Filing the Draft Prospectus: The company files a draft prospectus with the regulatory authority, including details about the IPO and the price range.
Bidding Period: The IPO goes through a bidding period during which institutional and retail investors submit their bids specifying the quantity of shares they want and the price they are willing to pay within the price range.
Price Discovery: As bids are collected, the lead managers and underwriters continuously assess the demand and the prices at which investors are willing to buy. This helps in price discovery.
Revision of Price Range: If necessary, the price range may be revised during the bidding period to better align with market demand.
Allocation of Shares: After the bidding period closes, shares are allocated to investors. Typically, priority is given to institutional investors. Retail investors may receive shares at the final price.
Book building example
In a book-building issue, the issuer announces a price range for the IPO instead of a fixed price.
For example, the company may specify a price range of Rs 601 – Rs 650 for its issue of 1 million shares. The lowest price in the price range, say Rs 601, is the minimum price and the highest price Rs 650 is the maximum price. Investors can place bids at any price within the specified price range or at the cut-off price (applicable to retail investors only).
Based on the demand and supply of the issue, the issuer determines the final price using the weighted average method. In this case, the issuer arrives at a final price/cut-off price of Rs 640 according to the procedure described above.
Case 1: Bidding above the cut-off price
The investors who had applied for the IPO at a price above Rs 640 may have a chance to receive an allotment. The investors will get back the amount above the minimum price. Example: If you have placed a bid at Rs 645 for 10 shares, you will get a refund as below:
| Scenario | Shares Applied | Bid Price (Rs.) | Application Amount (Rs.) | Cut-Off Price (Rs) | Shares Alloted | Refund (Rs.) | Refund Calculation |
| Full Allotment | 10 | 645 | 6450 | 640 | 10 | 50 | Refund of Rs 5 per share for 10 shares |
| Partial allotment | 10 | 645 | 6450 | 640 | 5 | 3250 | 1. Entire refund of Rs 645 per share for unalloted 5 shares.2. Refund of Rs 5 per allotted 5 shares. |
Case 2: Bidding below the cut-off price
All bids below the cut-off price will be rejected & the entire amount will be refunded.
Case 3: Bidding at the cut-off price
Investors who submitted their bids at the cut-off price may receive an allotment. In the case of a full allotment, no refund will be made; in the case of a partial allotment, the pro rata amount will be refunded to the extent of the shares not allotted.