What is Book Building?

Book building is the set of activities that an underwriter engages in to determine the price point for an initial public offering. The underwriter contacts institutional investors to ask about the price they are willing to pay for a new offering, and the number of shares they are willing to buy at that price. These inquiries are key to discovering the correct price at which to set a new share offering that satisfies both the investors and the owners of the entity going public. The steps involved in the process are as follows:

The business interested in going public hires an underwriter, which acts on its behalf to arrive at the price range at which it can sell shares, as well as to create a prospectus for issuance to the investment community.
The underwriter contacts major investors to ascertain how much they are willing to pay per share, and how many shares they want to buy.
The underwriter builds its book of business by itemizing the information submitted by the investors. Based on this information, the underwriter then determines the price at which the issuer can sell the planned amount of shares.
The underwriter then allocates shares to all of the investors willing to make purchases at the targeted price.

Though book building is a good way to gauge demand for a stock offering, it is possible that other factors will impact the offering price, such as market conditions on the days leading up to the initial public offering. Or, there is concern that the issuance is overpriced, which may depress the initial investor interest in the issuance, leading to an immediate stock price decline. This concern can lead the underwriter to recommend a slightly lower price to the issuer.