IPO Pricing

IPO price is the price at which shares in a company are offered to the public for the first time in an IPO. This can either be a fixed price, in which the price per share is predetermined, or a price range (book building), in which the price is determined by the company and its underwriters by setting a range, and investors bid within that range.

Pricing of the IPO is an important part of the IPO process, and it needs to be established prior to launching the IPO. Pricing must be accurate, or else the IPO will not be successful. If the price of the IPO is too high, investors may not invest, as they are afraid of losing money. Conversely, an underpriced IPO might raise concerns among investors, who usually think quality opportunities don't present themselves at bargain prices. Hence, finding the right balance in IPO pricing is essential in order to provide a fair listing and appropriate investor base.

The IPO price is determined by one of two methods: Book Building or Fixed Price. The issuing company can choose either method based on its preference. However, if the company is eligible for the mainboard but fails to meet the profitability norms set by SEBI, it must go through the QIB route, which requires the use of the book-building method for pricing the IPO.

In the book-building method, the IPO price is not predetermined. The issuing company discloses a range (e.g., ₹75 to ₹80 per share), within which offers are invited. The IPO price is set at the completion of the offer period, based on the demand at various price points.

Advantages of Book Building

• Effective Price Discovery: It helps establish the fair market price of the shares based on investor demand.
• Credibility Evaluation: The company can assess the interest and credibility of potential investors by observing the demand for shares.
• Realistic Pricing: The price is determined by market demand, rather than being arbitrarily set by the management.

Disadvantages of Book Building

• Costly Process: It tends to be more expensive than a fixed price IPO due to extra marketing and distribution costs.
• Longer Process: Since the final price is set after the bidding period, it takes more time to determine the price and allot the shares.
• Suitability for Larger Volumes: This process is more suitable for larger IPO volumes due to the complexity of price determination and handling the bids.

Features of Book Building

• No Fixed Price: The IPO is issued without a predetermined price. Instead, a price range is provided for the shares.
• Price Range Disclosure: The price range must be disclosed at least two business days before the subscription period opens.
• Price Revision: The price range can be revised during the subscription period if necessary.
• The IPO remains open for 3-7 working days, but it can be extended by up to three additional days if the price range is revised.
• Automated Bidding: Both BSE and NSE use fully automated web-based systems to handle the book-building process.

The IPO price band specifies the range of prices within which investors can place their bids during an IPO. The following are the key facts and characteristics of the price band:

• Price Range: The price band consists of a lower price and an upper price (e.g., ₹75 to ₹80 per share).
• Floor Price: The lower price is called the Floor Price or Base Price.
• Cap Price: The upper price is referred to as the Cap Price or Ceiling Price.
• Price Difference: The difference between the floor price and the cap price cannot exceed 20%.
• Retail Investor Application: Retail investors can apply for shares at any price within the range, or they can choose the Cut-off Price.
• Cut-off Price: The Cut-off Price is the highest price in the range at which shares will be allotted to investors. This price is determined once the bidding process concludes.
• Price Determination: The prospectus outlines the methodology used to determine the final IPO price.

Book building is a significant process in issuing an IPO in India. The Underwriters and Lead Managers primarily handle this process. Here's a quick and simple explanation of how it works:

Step-by-Step Guide to Book Building

• Setting the Stage: The lead manager, in collaboration with the issuing company, decides the number of shares to issue and sets a price band (minimum and maximum share price).
• Assembling the Team: Members of the syndicate are appointed by the lead manager and the company. They help distribute and process investor bids.
• Opening for Bids: Once the IPO is live, investors can submit bids for a specific quantity of shares within the price band.
• Price Discovery: After the bidding window closes, the lead manager reviews all bids and determines the final issue price, usually based on a weighted average.
• Transparency and Allotment: To maintain fairness, the lead manager releases the "basis of allotment," showing how the cut-off price was finalized.
• Final Allocation: Investors who bid at or above the cut-off price may receive shares. Those who bid below won't receive any, and their money is refunded.

When a company issues an IPO, it can choose how much of the offering will go through the book-building process. There are two main forms:

1. 100% Book Built Issue

In this method, the entire IPO (100% of the shares) is offered through the book-building process. The final price is determined solely based on investor bids.

2. 75% Book Built Issue

Here, 75% of the shares are issued through book building, while the remaining 25% are offered at a fixed price or at a price discovered during the book-building process.

Bidding Scenarios

• Case 1: Bidding Above the Cut-off Price: Shares will be allotted at the cut-off price, with refunds for the difference between bid price and cut-off price.
• Case 2: Bidding Below the Cut-off Price: Any bids placed below the final issue price (cut-off price) will be rejected, and the full payment made by the investor will be refunded.
• Case 3: Bidding at the Cut-off Price: Investors who bid at the cut-off price level may be allotted shares:
  • Full Allotment: No refund will be given.
  • Partial Allotment: A refund will be issued for the non-allotted shares, based on pro-rata distribution.

Note: When demand for the issue is high, the maximum price often acts as the cut-off price.

Book Building and Reverse Book Building

Book building is a method used in IPOs to raise capital from the public, whereas reverse book building is used when a company wants to repurchase its shares from shareholders.

Reverse book building follows the same concept as book building and is an effective pricing mechanism. In reverse book building, shareholders place sell orders at various prices. The company then determines the final price based on demand and supply. This method is primarily used during delisting.

In a fixed-price IPO, the price per share is determined in advance (e.g., Rs 75 per share) before the IPO opens for subscription. This method is often favored by small and medium enterprises (SMEs) due to the smaller size of the issue.

Features of a Fixed Price Issue

Unlike the book-building process, where the price is determined by investor bids, in a fixed-price issue, investors must apply at the price set by the company. Key details of a fixed-price IPO include:

• The IPO prospectus will specify the offer price and explain how it was determined.
• The issuer must register the IPO prospectus with the Registrar of Companies before opening for subscription.
• A minimum of 50% of the offered shares should be reserved for retail investors.
• The fixed-price offer typically remains open for 3 to 10 business days.

Fixed Price IPO Process

The fixed-price IPO process is simpler compared to the book-building process, as there is no need to determine the price through bidding. However, selecting the right price is still crucial for the company. Here's how it works:

• Appointing the Lead Manager: The issuing company appoints a lead manager to help evaluate key factors such as the company's financial status, growth potential, assets, and liabilities. Together, they agree on the size of the issue and the fixed IPO price.
• Opening the IPO for Subscription: Once the IPO is opened for subscription, investors can submit their bids at the fixed price.
• Investor Bidding: Investors place their bids at the price set by the company.
• Assessing Demand: After the bidding closes, the lead manager assesses the demand for the issue and works with the Registrar of Companies (RoC) to process the allotment.
• Allotment and Refunds: The Registrar finalizes the allotment process, credits shares to the Demat accounts of successful investors, and issues refunds to unsuccessful bidders, if applicable.

Fixed Price Issue Example

In a fixed-price IPO, the share price is predetermined, and investors must apply at that set price.

For example, if the IPO price is Rs 186 per share, investors can only apply at this price—there's no option to bid at a different price or at a cut-off. After the IPO closes, whether you receive an allotment depends on overall demand.

Scenarios:

• Scenario 1: Full Allotment: You applied for 1,000 shares and received the full allotment. → All 1,000 shares will be credited to your Demat account. No refund is issued.
• Scenario 2: No Allotment: You didn't receive any shares. → The full amount you paid (Rs 186,000) will be refunded.
• Scenario 3: Partial Allotment: You applied for 1,000 shares but were allotted only 200. → 200 shares will be credited to your account. → A refund of Rs 148,800 (Rs 186 × 800 unallotted shares) will be processed.