Book-building is a process by which financial entities or investors, such as investment banks and other institutional investors, participate in the initial public offering (IPO) of stocks listed on an exchange. Book-building usually leads to more accurate pricing for IPOs because it allows underwriters to gauge the investor demand for the stock. This information helps guide the IPO price.
The acronym “book” refers to bibliographies or catalogs, books or lists. During book-building, securities firms present details about their clients interested in buying shares of company stock before it goes public. Once this information is compiled into a list that shows how many shares each client wants, the IPO price is set using that information.
There are two main steps of book-building
Potential investors will receive information regarding the IPO offer
The IPO issuer firm will contact potential investors and provide information about the upcoming IPO offering. As part of this procedure, it is common for the firm to give a “thesis” or overview of the stock price after going public.
Investors may choose to express interest either orally or in writing. If they do not immediately express interest, they are not counted as participating in book-building until it closes. In this way, only those who have indicated an initial level of interest become part of the investor pool from which underwriters can estimate demand for shares.
The exchange begins book-building
Book-building begins after the issuer firm provides an overview of its IPO offering to potential investors. The book is built by adding names to a list of investors interested in buying shares once they are publicly traded. A specified period continues where interested parties can approach investment banks or others involved with the IPO to request information about the upcoming stock offering. This period usually lasts several days and ends at a “book closing time.” After this designated period has passed, no more names may be added to the list.
After book building closes, underwriters will use this investor demand data to estimate how many shares will be issued by the IPO issuer. They will also use this data to estimate how many shares are likely to trade in the public markets since traders can buy and sell securities on the stock exchange after the company goes public.
This process helps determine an appropriate price for the initial public offering of stocks. If there is high investor interest, then underwriters would set a higher share price for those shares. The result is that each share sold in an IPO should be sold at a higher price than if investors were less interested. In this way, book-building helps provide more accurate pricing and attracts more buyers to purchase company stock shares when it becomes publicly traded for the first time through an IPO.
How do investors use book-building?
Book-building allows investors to take a proactive role in determining share price, which can be appealing. In some cases, investors may even wait until the book-closing date, where they think that the IPO issuer has set a higher price for their share offering before deciding to buy these shares.
It is important to remember that participation in book-building does not guarantee success in buying shares of stock. If too many buyers are willing to purchase shares at a specific price, then the exchange will increase the initial share price for trading on its market. This could make it challenging or impossible for individual traders and smaller firms to purchase enough shares needed to meet demand from interested investors.
In this situation, brokers would likely receive an allocation of shares for investors who have made requests through book-building. This means they may purchase as many as the number requested, but not necessarily all of them. In this case, some investors might receive part of the shares they wanted, while others would have to wait until additional shares become available on the market later on after trading begins.
In some cases, however, demand from potential investors could be so strong that a company decides to sell more shares than initially specified in their IPO prospectus document. In this situation, underwriters may find it necessary to increase the share price or reduce the number of shares being offered by an issuer firm during its initial public offering. You can learn more here.
