Demystifying the book building process

Book building process can be adopted for any type of public issue and involves a process that is not well known to the common investors. A corporation can raise capital from the public by going in for various types of issues. Public issues are generally brought to raise fresh capital. However, this route may also be used to offload a part of the holding of existing shareholders.

The Initial Public Offer (IPO): An issue brought out by an unlisted company for the first time for either fresh issue of securities or an offer for sale of its existing securities or both to the public is called IPO. It will allow the issuer company to go for the listing and trading of its securities.

Follow on Public Offer (FPO): A fresh issue of securities to the public or an offer for sale to the public, through an offer document, by an already listed company is known as a FPO. An offer for sale in such scenario is permitted only if it is made to satisfy listing or continuous listing obligations.

Rights Issue (RI): An issue brought out by a listed company for issue of fresh securities to its existing shareholders as on a record date is called a Rights Issue. The rights are generally offered in a particular ratio to the number of securities held prior to the issue.

Normally, this issue enables the issuer company to raise capital without diluting the stakes of its shareholders unless they do not intend to subscribe to their entitlements.

Preferential Issue (PI): An issue of shares/ convertible securities which is neither a public issue not a rights issue. By listed companies to a select group of persons/ investors under section 81 of the Companies Act, 1956 are called a pi. This type of issue enables the companies to raise capital in a cost and time effective way and can be structured according to the needs of the entrepreneur.

SEBI has prescribed eligibility norms for the entities proposing accessing primary market for raising capital by way of public issue. However, no eligibility norms have been laid down for a listed company making a rights issue since it is an offer made to existing shareholders who are expected to know their company.

Entry Norm I (EN I) : Normally a company accessing primary market through public issue needs to comply with the following requirements :

  1. Net worth of at least Rs.1 crores in three years.
  2. If change in name, at least 50% revenue for preceding 1 year should be the new activity.
    There may be a few instances where a genuine company is not in a position to fulfill all the requirements mentioned above. SEBI has, therefore, provided two alternative routes to entities not complying with any of the above parameters for accessing the capital market. This provision makes the guidelines flexible and ensures that the genuine companies do not suffer unduly on account of rigidity of the criteria. The alternative norms are furnished below:

O R 

  1. The ‘project’ is appraised and participated to the extent of 15% by FIs/ Scheduled Commercial Banks of which at least 10% come from the appraiser(s).
    Besides complying with the aforementioned eligibility norms, the company is also required to satisfy the criteria of having at least 1000 prospective allottees in its issue.
  2. Public Sector Banks
  3. Rights issue by a listed company.

Prior to 1992, the issuer company was required to determine the price of an issue as per the formula/ guidelines stipulated by the regulator viz. Controller of Capital Issues (CCI).

The Securities and Exchange Board of India (SEBI), established in 1988, was made by the regulatory body with the necessary authority and powers to regulate and reform the capital market. Subsequently, the primary capital market in the country entered an era of free pricing of an issue as the control of pricing of capital issues had been abolished to provide easy access to the capital market.

The issuer is, therefore, no longer required to adopt the specific formula for determining the pricing and the regulator does not play any role in determination of the price of an issue.

In the circumstances, the pricing of an Initial Public Offer (IPO) assumes great importance since the company can raise free resources by way of premium. The issuer company needs to disclose in detail both the qualitative and quantitative factors justifying the issue price.

A price band of 20% (cap in the price band should not be more than 20% of the floor price) can be mentioned in the Draft Offer Documents filed with SEBI and actual price can be determined at a later date before filing of the Final Offer Document with SEBI / ROCs.

Instead of determining the price of an issue themselves, the issuer company and LM may like to adopt a process whereby the investor himself is allowed to determine the optimum issue price – the price the investor is willing to pay and that is acceptable to the issuer company.

This may be possible through a price discovery process, i.e., eliciting the responses of the investors at various prices and then determining the optimum price. The process of determining the price of a Public Issue based on the price discovery process is known a Book Building Process.

In other words, this interactive process allows the issuer company to determine the investor’s appetite for a security at a particular price and provides an opportunity for the market to discover price for securities.

The Book Building process, in brief, involves the following steps:

  1.  determination of a price band with a median at which the demand for the company’s security is maximum.
  2.  Fixation of price band for the issue by the issuer company in consultation with the lead manager and the book runner.
  3. Communication of the price bands of the investors for bidding.
  4. Bidding by the investors at a price they think appropriate.
  5.  Determination of the final price at which the issuer company is willing to issue the security.
  6. Determination of the number of shares to be issued at the final price based on the quantum of funds to be raised.

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About Mohan Manohar Mekap

Mohan Manohar is a blogger from India who founded Ittech back in 2007. He is passionate about all things tech and knows the Internet and computers like the back of his hand.