IPO Pricing

IPO pricing is one of the critical steps of the IPO process, which must occur before the IPO launch date. If the IPO price is too high, investors may be reluctant to invest in the company as it may result in losses. If the IPO is priced too low, it may cause investors to doubt the performance of the IPO because good things do not come at a low price. Therefore, the right pricing for an IPO is very important for a fair listing.

IPO Pricing Methods

The IPO price is determined by one of the two IPO methods - Book building or Fixed price . The issuing company may use either method, depending on its preference. (Unless the mainboard-eligible company is unable to meet the profitability norms prescribed by SEBI. In such a case, a company will have to go the QIB route, where it is mandatory for the issue to follow the book-building route.

1. Book Building Method

In the book-building method of issuance, the IPO price is not fixed in advance. The issuing company announces an IPO price range (e.g., Rs 75 to Rs 80 per share) within which bids for the IPO are accepted. The IPO price is determined at the end of the bidding period based on the demand for the shares at various price levels.

Book Building Advantages

The book-building method offers the following advantages to the company:

• An efficient mechanism for price discovery.
• The company can assess its credibility based on the demand for the issue.
• A realistic approach to pricing that is based on demand for the shares and not set by management.

Book building Disadvantages

Book building has certain limitations, which are listed below:

• Costly compared to a fixed issue IPO.
• Lengthy process for issuing shares as the price has to be calculated at the end of the bidding process.
• Suitable for large issuance volumes.

Book Building Features

• The IPO is launched without setting the final price of the issue.
• The issuer announces a price range for the issue. According to the regulations, the price range should be announced at least two business days before the opening of the issue for the subscription.
• The issuer can revise the price range for the offering during the life of the offering.
• A book-building issue must be kept open for 3-7 business days , although the period may be extended by three days if the price range is revised.
• BSE and NSE offer a fully automated online bidding system for book-building IPOs.

IPO Price Band Rules

The IPO price band is the range of the offer price within which investors can place their bids. Below are the key facts and features of a price range:

• A price band has a lower price and an upper price (e.g., Rs 75 to Rs 80).
• The lower price of the price range is called the Floor Price or Base Price , and the upper price of the price range is called the Cap Price or Ceiling Price.
• The difference between the lower price and the upper price should not exceed 20%.
• A retail investor can apply at any price within the specified price range or at the Cut-off price .
• The cutoff price is the final price within the price range at which the shares are allocated to investors.
• The cutoff price is known at the end of the bidding process.
• The basis for the price determination is stated in the prospectus.

Book building process explained

The book-building process is mainly carried out by the Lead Managers and the Underwriters. The following steps provide a brief overview of how the book-building process works in India

Book Building Process Steps

1. The lead manager appointed by the issuing company determines the issue size and price range for the IPO in consultation with the issuing company.
2. The lead manager and the issuing company appoint the syndicate members to perform the duties related to the IPO offering.
3. Once the IPO is launched, investors start bidding for the required number of shares at different prices within the price range.
4. At the end of the bid submission window, the lead manager collects the data from all bids and determines the final issue price using the weighted average method.
5. The lead manager must publish the details ( basis of allotment ) of all bids received to ensure transparency of the bidding process and derivation of the minimum price.
6. Once the cut-off price is determined, the investors who submitted their bids at a price higher than the cut-off price or at the cut-off price may receive an allotment. On the other hand, the bids that are below the cut-off price will be rejected and the investors will get back the entire subscription money.

Book Building Types

An issuing company may conduct the IPO in one of the following ways:

1. 100% Book Built Offer
   In this type of offering, the entire 100% of the issue may be offered through the book-building process.
2. 75% Book Building
   In this type of offering, 75% of the net offering can be offered through the book-building process and 25% can be offered at the threshold determined through the book-building process.

Book building example

In a book-building issue, the issuer announces a price range for the IPO instead of a fixed price.

For example, the company may specify a price range of Rs 601 - Rs 650 for its issue of 1 million shares. The lowest price in the price range, say Rs 601, is the minimum price and the highest price Rs 650 is the maximum price. Investors can place bids at any price within the specified price range or at the cut-off price (applicable to retail investors only).

Based on the demand and supply of the issue, the issuer determines the final price using the weighted average method. In this case, the issuer arrives at a final price/cut-off price of Rs 640 according to the procedure described above.

Case 1: Bidding above the cut-off price

The investors who had applied for the IPO at a price above Rs 640 may have a chance to receive an allotment. The investors will get back the amount above the minimum price. Example: If you have placed a bid at Rs 645 for 10 shares, you will get a refund as below:

Case 2: Bidding below the cut-off price

All bids below the cut-off price will be rejected and the entire amount will be refunded.

Case 3: Bidding at the cut-off price

Investors who submitted their bids at the cut-off price may receive an allotment. In the case of a full allotment, no refund will be made; in the case of a partial allotment, the pro rata amount will be refunded to the extent of the shares not allotted.

Note: If the demand for the issue is very high, the maximum price usually becomes the cut-off price.

Book building and reverse book building

Bookbuilding is one of the IPO methods to raise capital from the public, while reverse book-building is used when the company wants to buy back the shares from its shareholders.

Reverse book-building works on the same principle as book-building and is an efficient pricing mechanism. In reverse book-building, the shareholder submits sell orders at different prices. The company then decides on the final price based on supply and demand. Reverse book building is mainly used in the case of a delisting.

2. Fixed price issue method

In a fixed price issue, the offer price is fixed (e.g. Rs 75 per share) that is decided in advance before the IPO opens for the subscription. The SME companies prefer a fixed price issue over the book-building method due to the smaller issue size.

Fixed price issue features

Unlike a book-built issue, a fixed-price issue must be applied at the price set by the issuing company. Below are the key facts and features of a fixed-price IPO:

• The fixed-price IPO prospectus contains all the details about the IPO price and the basis for setting it.
• The issuer must register the fixed-price IPO prospectus with the Registrar of Companies before the issue is opened for subscription.
• At least 50% of the net offering of securities should be made available to retail investors.
• A fixed-price offering should be held open for 3-10 business days.

Fixed price IPO process

The fixed-price IPO method is comparatively simple compared to the book-building method because there is no price discovery. However, deciding the right price is very important for the issuing company. The following are the steps for a fixed price issue:

1. The lead manager is appointed by the issuer company. They jointly evaluate various factors such as the company's financial position, growth prospects, assets and liabilities, and decide on the size of the issue and the IPO price.
2. The bidding process takes place as soon as the IPO is opened for subscription.
3. Investors submit their bids at the set price.
4. The lead manager assesses the demand for the issue at the close of the bidding period and accordingly works with the company's registrar (RoC) for the allotment.
5. The Registrar completes the allotment, credits the shares to the Demat account and initiates the refund, if any.

Fixed price issue example

The price of an IPO under the fixed-price method is determined in advance.

For example, the issuer may announce a price of Rs 186 for its issue. Investors would place their bids at Rs 186. You do not have the option to bid at any other price or cut-off price. Once the issue is closed, you may or may not receive an allotment depending on demand.

Scenario 1:

You applied for 1000 shares and received a full allotment. In this case, the entire 1000 shares will be credited to your account and there will be no refund.

Scenario 2

You have not received an allotment. In this case, the full amount of Rs 186,000 will be refunded to you.

Scenario 3

You have received a partial allotment of 200 shares. In this case, you would receive a refund of Rs 148,800 (186*800 unallotted shares) and 200 shares would be credited to your account.