Every company requires capital for growth. It can either raise capital from internal sources or go public and raise capital from external sources by issuing shares. One of of the most popular means to raise money is through initial public offer (IPO).
Under an IPO, a company offers a percentage of its ownership, or equity, to new investors who acquire a stake in the company by buying its shares. The issuing company receives a capital from the funds raised and the investors receive a share in the company.
Generally, there are two methods of pricing shares. The first is to sell shares at a single fixed price while the second is the book building method.
In the fixed price method, the issuer values the company and prices the share at a pre-determined price.
Under the book-building method, companies generally offer shares to the general public at a price range wherein investors decide on the price. The bids are collected from investors at various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional investors as well as the retail investors. The issue price is determined after the bid closure based on the demand generated in the process.
The book-building method is more efficient as it solves the \"leakage\" of value often seen with fixed- priced IPOs. The price range is based on where comparable companies are trading and an estimate of the value of the company that the market will bear. The investors then bid to purchase an agreed number of shares for a price which they feel reflects fair value. By compiling a book of investors, the issuer can ascertain what price range the shares should be valued at, based on the demand of the investors who are going to buy them.
Globally, this method is favoured for its mutually beneficial nature. Investors get the shares at a fair price that typically has potential upside, and the issuing company receives fair compensation for the stake sale.
THE RIGHT BAND
- Companies offer shares to public at prices determined by the investors
- By compiling a book of investors, issuer can ascertain price range
The writer is chief investment officer, LIC Mutual Fund
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