When a company wants to expand without incurring debt, it goes public. The process by which a company opens its shares for subscription on the exchange is known as an initial public offering (IPO). Investors who subscribe to it become stakeholders, and the company receives a capital infusion. There are two types of IPO issues– fixed price and book-building. Let’s look at their definition and differences.
What is the Fixed Price IPO issue?
As the name implies, the price of such an issue is fixed. The issuing company and the merchant banker jointly decide on the subscription price after evaluating the company’s liabilities, assets, business risks, and growth potential.
The company discloses the share price during the IPO announcement in such an issue. Hence, as an investor, you must pay the total subscription price for it.
Suppose ABC Ltd. wishes to raise funds through an IPO and hires a merchant banker to assist them. After the company’s critical aspects evaluation, the share face value is fixed at Rs 100, and the IPO price is set at Rs 1,000.
Upon price fixation, the company applies with the Securities and Exchange Board of India (SEBI) and submits the Draft Red Herring Prospectus (DRHP). If DRHP meets SEBI requirements, the company can proceed with the issue.
What is a Book-Building Issue?
The investment banker decides the issue price in a book-building approach. They determine the price after assessing the company’s assets, liabilities, etc. The investment banker then engages in a round of discussions with top company officials to fix the price band.
The price band comprises the floor price and cut-off price. The former is the lowest price that the issue value can never fall below, while the latter is the highest price. The difference between these two prices is usually less than 20%.
The company’s subscription bids determine whether the IPO’s final price is at the cut-off or floor. In case of oversubscription, the price is the cut-off value. When the issue is undersubscribed, the price is at the floor value.
Assume fictitious ABC Ltd. wishes to raise an IPO through the book-building method.
After considering various factors, the merchant banker and ABC Ltd. executives issue 2,00,000 shares at a price band of Rs 1,000-1,100.
Following the end of the subscription period, the bids were as follows.
20,000 bids for Rs 1,000,
40,000 bids for Rs 1,030,
80,000 bids for Rs 1,070
60,000 bids for Rs 1,080.
The maximum amount that investors are willing to pay here is Rs 1,070. Hence, any bid lower than that will not receive the allotment.
Fixed vs Book-Building Issue: Primary Distinctions
|Particulars||Fixed Price Issue||Book Building Issue|
|Price||Price is fixed and pre-decided at the time of issue.||The price band is predetermined, but the final price is usually determined through a combination of market demand and negotiations between the issuing company and the investment banker.|
|Demand||They are in high demand because shares in this type of IPO may be undervalued, implying better profits.||You will notice demand and supply equilibrium because the price fixation occurs after the subscription is closed.|
|Payment||You must pay the entire subscription amount upfront. In case of non-allotment, you will receive a refund.||You are only required to pay the sum after the allotment of shares.|
|Reservations||Reservations for high-net-worth individuals (HNIs) are 50%, with the remaining 50% reserved for investors willing to invest less than Rs 2,00,000.||Reservations are 50% for qualified institutional investors, 35% for small investors, and the rest for others.|
In summary, the primary difference between fixed-price issues and book-built issues is that the price is determined by the company in the fixed-price issue. Whereas in a book-built issue, the price is decided by the demand from investors. However, there may be instances where the company has more influence over the price in a book-built issue or where investor demand plays a larger role in determining the price of a fixed-price issue.