What is 'Book Building'
Book building is the process by which an underwriter attempts to determine at what price to offer an initial public offering (IPO) based on demand from institutional investors. An underwriter builds a book by accepting orders from fund managers, indicating the number of shares they desire and the price they are willing to pay.
BREAKING DOWN 'Book Building'As initial prices are provided by investors, the book is created by listing the information provided during the predetermined time period before the book is considered to be closed. During this time, the underwriter focuses on getting information from potentially large-scale buyers and investors, as this gives an overview of what those most interested in purchasing the stock are willing and able to pay. Once closed, the underwriter analyzes the information to determine the initial selling price, also known as the issue price, for the particular offering.
Even if the information collected during the book building suggests a particular price point is best, that does not guarantee a large number of actual purchases once the IPO is open to buyers. Further, it is not a requirement that the IPO be offered at that price suggested during the analysis.
IPO Pricing Risk
With any IPO, there is a risk of the stock being overpriced or undervalued when the initial price is set. If it is overpriced, it may discourage investor interest if they are not certain that the company’s price corresponds with its actual value. This reaction within the marketplace can cause the price to fall further, lowering the value of shares that have already been secured.
In cases where a stock is undervalued, it is considered to be a missed opportunity on the part of the issuing company; it could have generated more funds than were acquired as part of the IPO.
Understanding the IPO Process
The IPO transitions a company from private ownership to a publicly traded company, allowing outside investors to purchase shares in the company and bringing the company a new source of revenue.
In order to begin the IPO process, the company must file with the Securities and Exchange Commission (SEC). Once the filing is complete, a group of bankers, known as the underwriters, begin to work on generating an appropriate initial price for the IPO. An appropriate exchange is then selected, and large-scale investors are sought during a period referred to as the road show. Once all of those stages are complete, a date is set for the distribution of shares to buyers found during the road show, and sales open to the general public.