In the book building approach to price setting, the price of an IPO is demand driven. The issuing company sets a floor or base price and a band within which an investor is allowed to bid for shares. The spread between the floor and the cap of the price band cannot be more than 20 per cent of the floor price. Then the company, through its lead managers, invites price bids from investors along with the quantum of securities that they would be willing to purchase at that price.

While the issue is open, all investors must submit their bids along with payment for the quantity of shares they have bid for. The payment due is calculated at their respective bid prices.

One of the lead managers, who is called the ‘book runner’, maintains an order book in which the investors demand and price bids are registered. Once the issue period is over, the book runner demarcates a cut off price, i.e., a price at which the issue will be fully subscribed on the basis of the quantity and price bids received. All bids that are below the cut off price are ignored and investors who have bid at the cut off price or above can purchase shares that have been allotted to them at the cut-off price. SEBI guidelines permit only retail individual investors to apply at the cut off price.