Book Building and the Price Band: How Demand Sets the Issue Price
Book building is how an issue price is discovered rather than decided: the issuer and its merchant banker set a price band, applicants say how much they will take at each price inside that band, and the price is read off the demand collected. The issue then settles at one price for everybody. The requirements governing the process are read at sebi.gov.in.
Everything below is India, and the scope is narrow. A band is set, demand at each price is gathered into a single record, that record becomes one number, and an application then falls on one side of that number or the other. The last part matters most: what a heavily filled book does not tell anybody, however loudly it gets repeated.
Underneath all of it sits an idea so plain that it is easy to walk straight past. Nobody knows what an issue is worth before asking, so an issue either guesses the price or goes and collects the answer. Book building is the collecting. Everything else in this guide is machinery for making that collection honest, readable, and the same for everybody at the end of it.
A familiar version of it runs as follows. A housing society has 40 covered parking slots and no idea what to charge for them. The committee could pick Rs 5,000 a month and see what happens. Instead the committee circulates a slip: at Rs 4,000 a month, at Rs 5,000 and at Rs 6,000, how many slots would each household take? The slips come back. At Rs 4,000 residents want 130 slots. At Rs 5,000 they want 62. At Rs 6,000 they want 31. The shape of those three numbers is the entire subject.
Read the three answers the committee is now holding. Only 40 slots exist, so at Rs 4,000 the slots are wanted three and a quarter times over, and at Rs 5,000 a little over one and a half times over. At Rs 6,000 only 31 slots are wanted. Fewer slots are wanted than the society has, so 9 would stand empty. The committee sets Rs 5,000: the highest of the three prices at which residents still wanted every slot the society had. The price fell out of the collection rather than out of anybody's opinion. Nobody on that committee chose Rs 5,000 in the sense of preferring it, and the residents filling in slips did not choose it either. Hold on to that sentence. An issue does the same thing with a great deal more paperwork.
What is book building, and what does it replace?
Book buildingDiscovering an issue price by collecting demand at each price within a band before the price is fixed. is the process of discovering an issue price by collecting demand at each price inside a band, before the price is fixed. The issue opens carrying a range instead of a number. Applications arrive carrying both a quantity and a price. The record those applications build is read at the end, and the price the issue settles at comes out of that reading rather than out of the document that opened it.
Book building replaces a guess. In a fixed price issueAn issue where the price is printed before any demand has been collected, so an applicant can only take it or stay away. the price is printed before anybody has been asked anything, and the market is handed exactly one instrument for replying: apply, or do not. Applying or staying away answers a yes or no question. The far more useful question goes unanswered: how much would have been taken at some other price. An issue priced before demand is collected can learn that it was wrong and can never learn by how much.
Vindhya Ceramics Private Limited, an invented unlisted manufacturer, raised its equity portion of Rs 25,00,00,000 this way. Ratnakar Deshpande, the finance director at Vindhya Ceramics Private Limited, and Sulekha Bhandari, who led the team at Trilokpur Capital Markets Private Limited, did not print a price. Ratnakar Deshpande and Sulekha Bhandari opened with a range and let the applications answer.
What is the Price Band, and who sets it?
A price bandThe range within which an issue price will be discovered, printed in the document that opens the offer. is the range inside which the price will be discovered. The band has a floor and a ceiling, it is printed in the document that opens the offer, and the price that eventually settles will be one of the prices inside it. For the Vindhya Ceramics Private Limited equity portion the band was Rs 96 to Rs 101 per share. The band of Rs 96 to Rs 101 was chosen by Ratnakar Deshpande with Sulekha Bhandari at Trilokpur Capital Markets Private Limited, and no requirement anywhere calls for a width of five rupees or for any other width.
Now the distinction that everything below depends on. The band is a decision. The price is not. The price came out of the demand collected inside the band. The issuer and its merchant banker decided the band, and no person at all decided the price. Two decisions, two different deciders, and only one of them belongs to anybody at the company.
The things a band is not are equally worth naming. A band is not a forecast, it is not a valuation, and the floor is not a promise about anything. A band is the boundary of the collection exercise: outside it no demand is being gathered at all, so nothing outside it can be discovered. How wide a band may be, and what has to be disclosed about it, are requirements read at sebi.gov.in. How a band should be chosen commercially is a different subject and is taught elsewhere.
In this invented issue, who set the band of Rs 96 to Rs 101, and who set the price of Rs 100?
How is demand actually collected inside the band?
Once the offer opens, an application is no longer a single instruction. An application carries two things: how many shares, and at what price inside the band. The pairing of quantity and price is a bidAn indication of how much an applicant will take at a stated price, which is the unit a book is built from., the unit everything downstream is built from. An application saying it will take a quantity at Rs 98 has said something a fixed price issue could never have heard: not only that it wants in, but where its ceiling sits.
The applications arrive through the bidding platform the exchanges operate, and they are recorded, verified and totalled while the offer is open. The Vindhya Ceramics Private Limited issue received 12,400 applications. On verification 340 were rejected, leaving 12,060 holders on the register when Suravali Registry Services Private Limited completed the allotment. An application that fails verification never becomes demand at any price. The book and the final register are therefore not the same document, and failed verification is only the first of several reasons why.
The record being built while all this happens has a name and a shape. The bookThe collected record of demand at each price, built up while the offer is open and read once it closes. is the collected record of demand at each price. The book is not a narrative and it is not an opinion. The book is a table, and by the time the offer closes it holds one row for each price in the band.
How is the book read, and why does cumulative demand matter?
Here is the step that trips people, and it is a small one. The number written against each price is not the demand at exactly that price. The number is cumulative demandTotal demand at a price and at every price above it, which is what an applicant willing to pay more is also willing to pay.: demand at that price and at every price above it. The reason is ordinary. Somebody willing to pay more is willing to pay less, so an applicant who said Rs 101 has already answered for Rs 98. So the row for Rs 98 counts them too.
Cumulative demand divided by the size of the issue gives coverageHow many times over the issue is demanded at a given price, found by dividing demand at that price by the issue size., expressed as times covered. Coverage of 2.6 times at Rs 98 means that at Rs 98 the applicants between them wanted two and six tenths of the whole issue. Coverage of 0.9 times means they wanted nine tenths of it and no more. At one times the demand exactly fills the issue, and below one times the issue is not filled at all. One times is the only number on the whole table with a meaning of its own.
The invented book for the Vindhya Ceramics Private Limited equity portion of Rs 25,00,00,000 filled like this.
| Price | Cumulative demand | Times covered | Fills the issue? |
|---|---|---|---|
| Rs 96 | Rs 85,00,00,000 | 3.4 | Yes |
| Rs 97 | Rs 77,50,00,000 | 3.1 | Yes |
| Rs 98 | Rs 65,00,00,000 | 2.6 | Yes |
| Rs 99 | Rs 57,50,00,000 | 2.3 | Yes |
| Rs 100 | Rs 47,50,00,000 | 1.9 | Yes, and it is the last price that does |
| Rs 101 | Rs 22,50,00,000 | 0.9 | No, short by Rs 2,50,00,000 |
Read down the last column rather than across the rows. The answer is not hidden anywhere in that table: it is the place where the word changes. The whole discovery is the point at which coverage falls through one times. Reading a book takes far less skill than people expect.
The band runs from Rs 96 to Rs 101. Before the control below is moved: at which end of that band should demand be heaviest?
Walk the price up the band one rupee at a time, and watch the moment the issue stops being covered.
The control opens at Rs 100, exactly the price this invented book discovered: coverage of 1.9 times, demand of Rs 47,50,00,000 against Rs 25,00,00,000 to be raised, and 25,00,000 shares. Step it up one rupee to Rs 101 and coverage falls to 0.9 times, the issue is short by Rs 2,50,00,000, and the price could not go there. The single rupee between Rs 100 and Rs 101 is why the price stopped where it stopped. The second view drops three invented applications onto the band and shows which of them sit at or above whatever price the control is holding.
Why does the price settle where it settles?
Run down the invented book for the Vindhya Ceramics Private Limited equity portion and watch one thing only. At Rs 96 coverage is 3.4 times. At Rs 97 it is 3.1. At Rs 98, 2.6. At Rs 99, 2.3. At Rs 100 it is 1.9 times, and the issue is still comfortably filled. At Rs 101 coverage is 0.9 times and falls under one: the demand collected at Rs 101 is Rs 22,50,00,000 against Rs 25,00,00,000 being raised, short by Rs 2,50,00,000. The discovered priceThe single price the issue settles at once the book has been read, which every successful applicant then pays. is Rs 100.
The rule this illustration applies is the plainest one available: the price settles at the highest price in the band at which the issue is still covered at least one times. Rs 100 clears that test and Rs 101 fails it. The price did not stop at Rs 100 because anybody preferred Rs 100, it stopped there because Rs 101 was the first price in the band where there was not enough demand to fill the issue. The whole discovery fits into one sentence because it is genuinely that small an idea.
The shape of the book does something worth naming as the rows run down. Demand falls as the price rises. Nothing in this subject is less surprising, and nothing matters more: the fall is the entire mechanism. If demand did not fall as price rose, no price would be discoverable: every price would look the same and the collection exercise would have gathered nothing worth reading. Book building works because ordinary people want less of something the more it costs, and the book is simply that fact written down in rupees.
Coverage on this invented book is 1.9 times at Rs 100 and 0.9 times at Rs 101. Where does the price settle, and why?
Where these requirements are read
The process itself, what the document opening the offer has to carry, how bids are received and revised, and how allotment is made among the applications that qualify, all sit in the issue of capital and disclosure requirements made by the Securities and Exchange Board of India, read at sebi.gov.in. Company law reaches the same issue at a different point, through the Ministry of Corporate Affairs at mca.gov.in. The permitted width of a band, the share of an issue that may go anywhere and the period for any step are read there. The rule used above, that the price settles at the highest price still covered one times, is the rule this illustration applies. The current version at the site named carries the requirement in force on the day it is needed, and a requirement half remembered is worth less than no requirement at all.
What does the discovered price do to the amount being raised?
Until the book is read, the Vindhya Ceramics Private Limited equity portion is an amount of money and nothing else: Rs 25,00,00,000, with no number of shares attached to it. The discovered price is what converts that amount into a count of shares that will exist afterwards. Rs 25,00,00,000 divided by Rs 100 is 25,00,000 shares. The 25,00,000 shares are what the 12,060 holders on the register after allotment hold between them. The average works out at a little over 207 shares each, and that average is arithmetic rather than anything anybody was promised or allotted.
Rs 100 has a tidy property worth pointing at, and the property will not hold anywhere else in the band. Rs 25,00,00,000 divides into Rs 100 exactly. The same amount does not divide exactly into Rs 96, Rs 97, Rs 98, Rs 99 or Rs 101, so at any of those prices the last few rupees do not buy a whole share and the count has to stop at the last whole one. The discovered price is what turns an amount of money into a number of shares, and until the book has been read the company does not know how many shares it is about to bring into existence.
Rs 25,00,00,000 is being raised and the book discovers a price of Rs 100. How many shares come into existence?
What happens to an application made above the discovered price?
An application that bid Rs 101 in this invented issue said it would take shares at Rs 101, and the book settled at Rs 100. Two things follow, and only the first one is obvious. The application sits at or above the price the issue settled at, so it is inside the set of applications that can be allotted. And it pays Rs 100, not Rs 101. The issue settles at one price, and every successful applicant pays that same price. Bidding above the discovered price is about being inside the set rather than about paying more.
The single price surprises people who think of a bid the way they think of an auction for a single object, where the highest bidder pays what they said. An issue is not that. An issue is one company selling many identical shares and it needs one price, so the price it discovers becomes the price for everyone who is allotted. Bidding higher inside the band buys a better chance of being on the right side of wherever the price lands, and it never buys the shares at the higher number.
What happens to an application made below the discovered price?
An application that bid Rs 96 said, in effect, that Rs 96 was as far as it would go. The book settled at Rs 100. The application sits below the price the issue settled at, so it is outside the set of applications that can be allotted at that price. The applicant is not asked to pay Rs 100 either, never having said they would. Nothing punitive has happened. The applicant stated a ceiling and the discovery landed above it.
Which side an application ends up on is therefore not a matter of merit and not a matter of when it arrived. Which side an application lands on is a matter of where the number written on it sits against a number nobody knew yet when it was written. An applicant who does not know where the price will land cannot know which side of it they are on. A bid carries a price at all, rather than just a quantity, for exactly that reason. How allotment is then made among the applications that do qualify, and what happens where they exceed the shares available, is set in requirements read at sebi.gov.in and is not described here.
An applicant bids Rs 101 and the book discovers a price of Rs 100. Is Rs 101 paid?
How does book building differ from an issue at a fixed price?
Set the two next to each other and the difference is not a matter of degree. The difference is the order of two steps. A fixed price issue sets the price first and collects demand afterwards. A book built issue collects demand first and sets the price afterwards. Everything people say about the two, all of it, follows from that one reversal.
A fixed price issue therefore has to guess, and its result is a single fact: the issue was subscribed, or it was not. If it was subscribed many times over, nobody learns whether a higher price would also have filled it. If it was not subscribed, nobody learns what price would have worked. A fixed price issue produces one bit of information about the price it chose. A book produces a reading at every price in the band, so the same exercise answers a question the other one cannot even ask.
What does an issue at a fixed price have to do that a book built issue does not?
What does the book not tell anybody?
A book is a record of what was indicated at each price while the offer was open. A book is not a record of what was finally paid for, and the two can differ. In this invented issue they did. The book showed 1.9 times coverage at Rs 100, or demand of Rs 47,50,00,000. The public finally subscribed 88 per cent of the equity portion, Rs 22,00,00,000, leaving a shortfall of Rs 3,00,00,000 that Trilokpur Capital Markets Private Limited took up in full inside its commitment of Rs 6,00,00,000.
How can a book showing demand of nearly twice the issue end with a shortfall? Because the two numbers count different things at different moments. A bid is an indication made while the offer is open. Subscription counts what is finally applied for, funded and verified: of 12,400 applications, 340 were rejected on verification alone. An indication of demand and a paid up application are not the same object, and the distance between them is precisely why an underwriting commitment exists at all. When bids may be revised or withdrawn, and what has to back an application, are set in requirements read at sebi.gov.in.
Then there is the larger silence, and it is the one readers mind most. A book records what people would take at each price. A book records nothing whatever about whether the price is the right one. Every applicant in the book was answering the first question and not the second, so no amount of demand can answer whether the price is right.
What is the one thing most readers want from a book and cannot get out of it?
The reading that turns a full book into a verdict on value
Here is how it goes, and it goes this way because the sentence is short enough to travel. The book fills. Somebody says the issue was covered 3.4 times at Rs 96. The number gets repeated, in a message thread, in a headline, across a lunch table. By the third repetition the number has stopped being a fact about applications and has quietly become a fact about the company: a queue this long must mean the shares are cheap.
The wrong reading is that coverage measures value. It does not. Coverage measures demand at a price. Heavy demand at a low price says what people would take if it were cheap: a statement about the price sensitivity of applicants, and not a statement about what anything is worth. The same book that was covered 3.4 times at Rs 96 was covered 0.9 times at Rs 101, five rupees higher. Both numbers are true at once. Neither of them is a measurement of worth, and nothing else would let both stand together.
Somebody who takes a full book as a reason in itself has picked up a fact about other applicants and read it as a fact about the company. The cost falls on them, and a book holds nothing to check that reading against. And the habit generalises badly: anywhere in finance, a queue is evidence about the people standing in it, not about the thing at the front of it.
An issue is covered 3.4 times at the bottom of its band. Does that mean the price is low?
What does a reader actually do with a book once the issue is over?
Once the issue has closed and the document carrying the discovered price has been filed, the book stops being news and becomes a small body of evidence to check things against. Three checks are worth knowing, and none of them is a view about anything.
The first is arithmetic. The amount being raised, divided by the discovered price, should give the share count printed in the document. For this invented issue it does: Rs 25,00,00,000 at Rs 100 gives 25,00,000 shares. An analyst does this because the share count is the input to almost everything else that gets calculated afterwards, and reading it off a document without dividing it once is how a wrong number travels.
The second is the shape. Coverage at the bottom of the band set against coverage at the top shows how sensitive the applicants were to price, not how good anybody thought the company was. In this invented book, five rupees of price moved coverage from 3.4 times to 0.9 times. A lender or an analyst reads that as a demand profile and writes nothing about worth beside it.
The third is the gap. Compare what the book indicated with what was finally subscribed and funded. The difference is where an underwriting commitment did its work: Rs 3,00,00,000 in this illustrated issue. Every one of these three checks is a reading, and not one of them is a view about whether anybody should have applied. A household applying in an issue gets the same three checks and no more: what price was discovered, how many shares that made, and how far indication and subscription ended up apart.
How a price band should be chosen is a commercial decision taught elsewhere. How wide a band may be, what portion of an issue may go to anybody, and when any step must happen are read at the source named below. Anchor allocation is set out under anchor investor, lock-in under lock-in, and what the document opening an offer must carry under the offer document and the red herring prospectus, while what changes for a company on the day it lists is set out under listing. How a price behaves once it is listed is a separate subject, and no book, however full, settles whether an issue was worth applying to.
References
| Source | Document | Where |
|---|---|---|
| Securities and Exchange Board of India | The issue of capital and disclosure requirements, named here for the existence of a book built route, of a band printed in the document that opens an offer, and of requirements governing bids and allotment | sebi.gov.in |
| Securities and Exchange Board of India | The circulars and operating instructions issued under those requirements, named for the existence of a process by which bids are collected, revised and verified while an offer is open | sebi.gov.in |
| Ministry of Corporate Affairs | Company law where it reaches a public issue, named so that a reader knows the document filed after an issue closes answers to a second address as well as to the securities regulator | mca.gov.in |
| The exchanges, on their own sites | Named for operational fact alone: the bidding platform through which applications reach an open issue, and the demand figures displayed while it is open | nseindia.com, bseindia.com |
| The depositories, on their own sites | Named for operational fact alone, being where allotted shares are credited once the price has been discovered and allotment made | nsdl.co.in, cdslindia.com |
Vindhya Ceramics Private Limited, Trilokpur Capital Markets Private Limited, Suravali Registry Services Private Limited, Ratnakar Deshpande, Sulekha Bhandari and the housing society near the top are invented.
Educational material. Not advice on any investment, tax, budget or market position.