Book building is a method of price discovery. In this method, offer price of securities is determined on the basis of real demand for the shares at various price levels in the market.
As defined by SEBI guidelines, 1995, “book building is a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda of offer document.”
In book building method, the final issue price is not known in advance. Only a price band is determined and made public before opening of the bidding process. The spread of price between floor price and cap in the price band should not be more than 20%. It means that the cap should not be more than 120% of the floor price. The issuer company appoints a merchant banker as book runner lead manager (BRLM), who may be assisted by other co-managers and by a team of syndicate members acting as underwriters to the issue. The BRLM sends copies of Red Herring Prospectus to the Qualified Institutional Buyers (QIBs), large Investors, SEBI registered Foreign Institutional Investors (FIIs) and to the syndicate members.
BRLM also appoints brokers of the stock exchanges, called bidding centers. They accept the bids and application forms from the investors. These bidding centers place the order of bidders with the company through BRLM. They are liable for any default, if any, made by their clients, who have applied through them. Brokers/Syndicate members collect money from clients/ investors. Money received by them at the time of accepting bids is called margin money. Bids can be made through on-line and transparent system of National Stock Exchange and Bombay Stock Exchange depending upon the agreement of the issuer with the stock exchange(s). An issue through book building system remains open for 3 to 7 working days. In case of revision of price band, it can be extended by 3 days. Rights issue remains open for at least 30 days and not more than 60 days.
The BRLM, on receipt of the feedback from the syndicate members about the bid price and the quantity of shares applied builds up an order book showing the demand for the shares of the company at various prices. The syndicate members must also maintain a record book for the orders received from institutional investors for subscription to the issue out of placement portion.
On the completion of book building process, the final price is determined by Issuer Company in consultation with the BRLM. Then the BRLM files final offer document with the Registrar of Companies before allotment of shares. The final offer document mentions the issue size and the offer price discovered through book building process.
Book building method is a flexible method for the issuing company as well as the bidders. The issuing company has the option to withdraw the offer from the market if the demand for the securities does not exist. The bidders can revise their bids before the closing of bidding process and offer different quantities at different prices. The investor can change or revise the quantity or price in the bid using the form for changing/revising the bid that is available along with the application form. However, the entire process of changing or revising the bids is to be completed within the date of closure of the issue. The investor can also cancel the bid anytime before the finalization of the basis of allotment by approaching/ writing/ making an application to the registrar of the issue. The syndicate member returns the counterfoil with the signature, date and stamp of the syndicate member. Investor can retain this as a sufficient proof that the bids have been accepted by the trading / syndicate member for uploading on the terminal.
In Indian primary capital market, book building process was introduced in 1995 on the recommendations of an expert committee appointed by SEBI under the Chairmanship of Y.H.Malegam to review the existing disclosure requirements in offer documents and the basis of pricing the issue. Initially, book building process was permitted for placement portion of the issue and for the issues exceeding Rs. 100 crores. But no issuer company used this process for pricing their issues till the end of 1998 due to stringent entry norms of SEBI and the bearish conditions in the Indian capital market. In 1998-99, SEBI reduced the issue size limit of Rs. 100 crore to 25 crore in order to encourage the use of this method. On the suggestions of market intermediaries, SEBI issued modified guidelines during the year 1999-2000, whereby the issuer company was given the option to book build either 90% of the net public offer or 75% of the net public offer. The balance of the issue was allowed to be offered to the public at fixed price, determined through book building process. In 1999-2000, an IT company, Hughes Software Systems Ltd. was the first company to use book building process for its initial public issue of equity shares amounting to Rs.275.63 crore. The issue was oversubscribed by 26 times and its books were built at the upper ceiling of the price. During the year 2000-01, both unlisted and listed companies were allowed to make public offerings through book building route after satisfying the eligibility norms set by SEBI. These norms required pre issue net worth of not less than one crore in three out of five years and a track record of distributing profits for at least 3 out of preceding 5 years; and issue size not exceeding 5 times its pre issue net worth for unlisted companies and not more than 5 times of pre issue net worth in case of listed companies.
The minimum issue size limit of Rs. 25 crore was removed by SEBI in 2001 in order to broaden the base of book building facility. Further, in August 2003, the new criterion of net tangible assets was added besides appraisal route as an alternative to the mandatory book building route. The new guidelines require that the issuer company should have net tangible assets of at least 3 crore for 3 full years, of which not more than 50% should be held in monetary assets. The SEBI has amended these guidelines from time to time in order to make the price discovery process more realistic.
Types of Book Building Process
Three types of options have been provided by SEBI to the issuer companies under book building. These options are as follows:
- 75% Book Building, 25% Fixed Price Offer: In this type of offer, 75% of the issue is offered to institutional investors who participated in the bidding process. Balance 25% is offered to the public through prospectus and shall be reserved for allocation to individual investors who had not participated in the bidding process. The price for 25% offer is the price as determined through book building. First, the book building portion remains open for 3 to 7 days and on discovery of issue price after the completion of book building process, the fixed price portion opens for subscription.
- 90% Book Building, 10% Fixed Price Offer: Here issuer company offers 90% of the issue through book building and the balance 10% through fixed price offer at a price discovered through book building. This option was available to the issuers during 1999-2000 and 2000-01 and later on discontinued by SEBI.
- 100% Book Building Offer: In this type of offer, the whole issue is offered through book building route. Issue opens and closes on the same dates for all categories of investors. Different categories of bidders bid at the point of time. This type of issue takes minimum number of days for the completion of the process of issue and allotment of shares. Generally, the issue is listed on a Recognized Stock Exchange after 3 weeks from the closure of the issue (2 weeks for completion of allotment +1 week for completion of listing formalities).
Allocation/ Allotment Procedure in Book Building Issues
In case of 100% one stage book building, the allocation to Retail Individual Investors (RIIs), Non Institutional Investors (NIIs) and Qualified Institutional Buyers (QIBs) is made in the ratio of 35:15:50 respectively. Retail Individual Investor (RII) means an individual who offers for securities up to the value of Rs.2,00,000 and Non Institutional Investor means an individual, who applies for securities for value exceeding Rs.2,00,000 ( limit revised by SEBI from Rs. 50,000 to Rs. 1,00,000 vide circular no. SEBI/CFD/DIL/DIP/15/2005/29/3 dated March 29th 2005. In SEBI Board meeting held on October 25, 2010 (PR No. 231/2010), this limit was further increased to Rs. 2,00,000). In case the book built issue is made pursuant to the requirement of mandatory allocation of 60% to QIBs in terms of Rule 19(2) (b) of Securities Contract (Regulation) Rules (in case of big issues where issue size exceeds five times pre-issue net worth of the issuer company), then allocation to RIIs, NIIs and QIBs is made in the ratio of 30:10:60 respectively. When book building issue is made on ‘75% Book Building and 25% fixed Price’ basis, the allotment to RIIs, NIIs and QIBs is made in the ratio of 25:25:50 respectively. In case of 90% book built issues, a minimum of 15% of the offer size was reserved for individual investors who made bids through the syndicate members and the balance of book built portion was available for allocation to investors other than retail investors. The 10% fixed price portion was allotted to individual investors who could not participate in book building process. All applicants are allotted shares on a proportionate basis within their respective investor category. Earlier, the applicants of QIBs category were allotted shares on discretionary basis which was later on discontinued by SEBI in September, 2005.