Book Building

Book building is the method by which the banks managing an offering of shares or bonds collect indications of demand from investors and use them to decide the final price and who receives how much. The "book" is the record of orders, showing the quantity each investor wants and, where given, the price it is prepared to pay. It is the standard approach for an initial public offering (IPO), for follow-on share sales and for syndicated bond issues in most major markets.

The process serves price discovery for a security that has no market price yet. It replaced, in most countries, the older fixed-price offer, in which the price was set before demand was known. Book building is run by one or more investment banks acting as bookrunners, which lead the underwriting syndicate and work with the issuer throughout.

An IPO book build usually proceeds as follows. Before launch, the banks' analysts and sales teams meet selected institutions to explain the business and gather early views on value, a phase often called pre-marketing or investor education. The issuer and banks then set an indicative price range and publish it with the prospectus.

Management goes on a roadshow, typically lasting one to two weeks, presenting to institutional investors. During this period investors submit orders to the bookrunners. An order may be at any price within the range, limited to a maximum price, or stepped, with different quantities at different prices. Orders are not binding until the investor confirms after pricing, but investors are expected to honour them.

When the book closes, the bookrunners analyse total demand at each price and the quality of the investors behind it. The issuer and banks agree the final offer price, usually within the range, and decide allocations. Shares begin trading on the exchange shortly afterwards.

The price is not simply the highest level at which the book is covered. Issuers and banks normally choose a price that leaves the offer oversubscribed, so that there is unfilled demand to support trading afterwards. An offer may be covered several times over at the chosen price.

Allocation is discretionary. Bookrunners recommend, and the issuer approves, how many shares each investor receives; this is covered in more detail under IPO allocation. Preference is commonly given to investors expected to hold the shares for the long term, to those who gave early and informative feedback on price, and to those who placed orders early and at firm levels. A portion may be reserved for retail investors, who usually apply at the final price without taking part in setting it.

To support the price after listing, the banks often sell more shares than the base offer and cover the excess through a greenshoe option granted by the issuer or selling shareholders. Trading by the banks to steady the price in the first weeks is permitted within the rules on stabilisation.

In a bond issuance, the same process is compressed into hours. The bookrunners announce initial price guidance as a spread over a benchmark, investors enter orders, guidance is revised as the book grows, and the final spread is set once demand is clear.

Listed companies and large shareholders use an accelerated book build to sell shares quickly. The banks contact institutional investors after the market closes, build the book in a few hours and price the shares at a discount to the last traded price, without a roadshow or a full prospectus. The short timetable limits exposure to market movements. The method is related to a block trade, in which a bank buys the shares outright and resells them.

Under a fixed-price offer, the price is announced first and investors apply for shares at that price. It is simple and open to all, but the issuer bears the risk of mispricing. In an auction, such as a Dutch auction, investors bid and shares are allotted at the clearing price by rule, with no discretion for the banks. Auctions have been used for a few prominent listings but remain uncommon for shares. In a direct listing, existing shares simply begin trading with no offering.

Supporters of book building argue that discretion over allocation induces well-informed investors to reveal what they think the security is worth.

The main criticisms concern underpricing and conflicts of interest. Shares in IPOs rise on average on the first day of trading, which means issuers raise less than they might have, and the gain goes to investors who received allocations. Because banks control allocation, they can favour clients who generate other business for them.

Regulators have responded with rules on allocation policies, record keeping and the management of conflicts. In the European Union and the United Kingdom, firms must have an allocation policy, record the reasons for allocation decisions and avoid practices that link allocations to other business. Research analysts connected to the offering are subject to separation and quiet-period requirements. Admission of the shares to trading is covered under listing admission, after which trading moves to the secondary market.