People are not as familiar with the Book Building system in Nepal as they are with the normal process. The number of companies adopting this system is increasing in Nepal. Additionally, companies are all set to introduce the Book Building system in Nepal. For decades, Nepal has been applying the traditional method which is a normal process.
Surprisingly, nowadays companies are starting to adopt book building Systems in Nepal too. There is great potential for the Book Building system in Nepal. Sarbottam Cement is the first company to issue its IPO through a book building system in Nepal.
What is Book Building System?
Book Building is the process of price discovery in an Initial Public Offering (IPO). It is a method where bids are collected from different investors at a various price, which is above or equal to the floor price.
The company hires a merchant bank to determine a price range at which they issue shares instead of a fixed price. This process allows the company to issue IPO at a premium (higher) price. In a normal process, the price of an IPO is Rs 100 per share. Companies who are eligible for the book building method can issue IPO at a premium price.
Recently, this system has come into practice in Nepal. We will definitely be able to see more companies issuing their IPO via book building, and you can find more about that on Upcoming IPO’s in Nepal 2021.
Normal Process Of IPO Issue
The normal process is a simple method that we have been applying for centuries. There is no research and no bidding in this process. Under fixed price, a company going public determines a fixed price and issues the shares to the investors.
Investors know the share price before a company goes public. The share demand of a particular firm in the market is only known once the issue is closed. To partake in this IPO, Investors must pay the full fixed share price while applying for it.
It is quite an easy and simple process to issue IPO. Small investors prefer the normal process as they don’t need a large amount of money to invest compared to book building. It is less risky for the people and really flexible in the secondary market while selling.
Book Building Process Of IPO Issue
Book Building Process is considered to be the most efficient method as several developed countries have been applying it. Under book building, Companies going public offer a 20% price band on shares to investors. Then investor bids on the shares before the final price is determined once the bidding has closed.
Investors must specify the numbers of shares they want to buy and how much they are going to pay. There is no fixed price per share in this system. The Floor price is known as the lowest share price, while a Cap price is known as the highest share price.
After a company issues IPO through book building, bidding takes place. When it completes the bidding process, the price of the shares will be 10% discounted to the general public compared to the institutional investors. A company adopting this method has a high possibility of providing profit and bonuses.
This method helps to generate a large amount of capital and brings higher net revenue. The company is able to gain relevant price information from potential buyers. It provides access to the stock market and liquidity to the investors.
What Are The Requirements For Book Building System?
There are many companies who want to adopt this system, but every company cannot issue their IPO through book building. Any random company cannot apply this method. The company needs to meet certain requirements and criteria. Here are some criteria made by SEBON:
- According to the directive published by SEBON, the firm must have been making a profit for three consecutive years.
- The general meeting should approve the issue of the IPO.
- Net worth per share of the company must be at least 50% of the paid-up capital.
- ICRA NEPAL rating needs to be average or above average.
- A company which fails to meet these criteria will have to issue their IPO at Rs 100.
- After the IPO’s price determination, a provision allows the sale of 40% of the total shares to institutional investors and 60% to the general public.
- Only Institutional investors, Merchant bankers, Collective investment funds, Listed associates, and Recognized retirement funds approved by the securities board would be worthy to participate in the bidding/auction under this method.
If the companies can meet these requirements/criteria, they will be allowed to issue their IPO through a book building system.
Role Of Merchant Bank in Book Building
The company hires a merchant bank to decide the price range at which shares are to be issued. It is known as book runner or underwriter. The bank is responsible for researching and analyzing the issuing company comes up with the best price for its IPO shares according to the demand.
Merchant banks research and invite mutual funds, large-scale buyers, other institutional banks, and small investors. They submit bid prices along with the number of shares in which they have buying interest.
Once the merchant bank determines the price range, then they make a prospectus welcoming the investors to apply for the shares. That’s how merchant bank is responsible for the process.
Advantages Of Book Building
There are many benefits of book building. Some of them are as below:
- Book building helps to determine the price of the shares in a more realistic way.
- The issuing company gets the maximum price of the stock.
- The company is able to choose the quality investor.
- It helps the issuer to save a lot of money on advertising and broker commission.
- There is a high possibility of profit due to this system.
- Higher transparency while allotting the shares.
- The issuer can issue the IPO at a premium price.
Disadvantages Of Book Building
Book building may not be beneficial every time. There are limitations of this system too, and the disadvantages of this system are briefly below:
- This method is suitable for large issues only. So, small companies cannot adopt this system.
- Large investors may try to manipulate the price or possibility of rigging as they try to save organization members.
- The issuing company should be well known to the public and fundamentally strong.
- Book Building is costly, unlike the normal IPO process.
- It takes more time which may disrupt company development.
Frequently Asked Questions
Is Book Building System Expensive?
Compared to normal price offerings, the share price is higher as the company issues its IPO at a premium price. Only those companies having huge capital and have been making a profit can adopt this system. Although it may be expensive, it is the most efficient method.
Developed countries have been applying this method for decades. There is a high possibility of profit in this type of company as it is fundamentally sound. It is unfair to say the price is expensive; the thing is that it isn’t cheap as normal IPOs.
Why was Book Building System Introduced?
In order to overcome the problem of high pricing, book building was introduced in 1995. This method helps to discover the right price for a public issue. Large Companies have heavily benefitted from this system as they can collect enough capital for their production.
It helped companies to go public. There is transparency in this system while the shares are distributed to the general public.
Does Book Building Make Company profitable?
As the company is able to generate a large amount of money, it definitely boosts production and helps to expand the firm further. Only qualified companies are able to issue IPO through this system which makes the company reliable and trustworthy. It definitely makes a company successful.
Will Nepal Adopt Book Building System?
Looking at the current scenario in the Nepali share market, it tough to predict it. But people will definitely be intrigued by this process, and hopefully, in the future, we may see the majority of the company applying this method. Though, as of right now, people are less familiar with this system.
The book-building system is the most efficient and reliable system. Companies applying this method have benefitted heavily while satisfying the investors too. The possibility of profit is higher in this system. Hence,the true potential of the firm is unleashed due to the heavy capital generate from it.
Personally, I think countries like Nepal should definitely adopt this method as it will help to strengthen the country’s economy and uplift the share market. Although this system is efficient, it is unfair to small investors as they need more money to invest compared to the normal process.
Moreover, this system has great potential, and hopefully, we may see these methods adopted by more companies who are qualified. In the future, the book-building system will be well renowned all over the world. Every major company that wants to diversify its business globally will apply this method.