Book building is a technique used for marketing a public offer of equity shares of a company. It is a way of raising more funds from the market. After the start of free pricing mechanism by the SEBI, the book building process has become a significant method of raising funds.
A company can use the process of book building to fine tune its price of issue. When a company employs book building mechanism, it does not pre-determine the issue price (in case of equity shares) or interest rate (in case of debentures) and invite subscription to the issue.
Instead it starts with an indicative price band (or interest band) which is determined through consultative process with its merchant banker and asks its merchant banker to invite bids from prospective investors at different prices (or different rates).
Those who bid are required to pay the full amount. Based on the response received from investors the final price is selected. The merchant banker (called in this case Book Runner) has to manage the entire book building process.
Investors who have bid a price equal to or more than the final price selected are given allotment at the final price selected. Those who have bid for a lower price will get their money refunded.
Book Building Options
In India, there are two options for book building process. One, 25 per cent of the issue has to be sold at fixed price and 75 per cent is through book building. The other option is to split 25 per cent of offer to the public (small investors) into a fixed price portion of 10 per cent and a reservation in the book built portion amounting to 15 per cent of the issue size. The rest of the book-built portion is open to any investor. Further, shares may be issued to retail investors at some discount than other investors.
Such discount should be specified in the prospectus. The greatest advantage of the book building process is that this allows for price and demand discovery. Secondly, the cost of issue is much less than the other traditional methods of raising capital. In book building, the demand for shares is known before the issue closes. Infact, if there is not much demand the issue may be deferred and can be rescheduled after having realised the temper of the market.
Public issues are targeted at various segments of the investing fraternity. Companies allot certain portions of the offering to each of the segments so that everyone gets a chance to participate. The segments are classified into Qualified Institutional Bidders (QIBs), High Net worth Individuals (HNIs) and Retail Investors (general public). Indian companies now have to offer about 50% of the offer to QIBs, about 15% to HNIs‟ and the remaining 35% to retail investors. Earlier retail and HNIs‟ had 25% each.
Also the QIBs are allotted shares on a pro-rata basis as compared to the earlier norm when it was at the discretion of the company management and the investment bankers. These investors (QIBs) also have to pay 10% margin on application. This is also a new requirement.