How is pricing of an IPO done?

There are typically two ways in which IPOs are priced. One is called the fixed price method and then there is the Book Building method. IPOs can be made through the fixed price method, book building method or a combination of both

In the fixed price method, the price at which the securities are offered is fixed in advance. For instance, Intellect Ltd., a company proposing IPO, may decide to offer shares at Rs.50 per share.

In the book building method, however, the investors have to bid for shares within a price band specified by the issuer and the final price is decided after considering the bids received. A price band is nothing but a range of price within which the shares may be offered based on demand. In our example, Intellect Ltd. may instead decide on keeping a price band of Rs.45 to Rs.50 per equity share. In this case, some investors would bid at Rs.45, some at Rs.46, some at Rs.50 and so on. After the IPO is closed and all bids are received, if the company finds sufficient demand at Rs.50, then it may decide to offer shares at that price. In contrast, if sufficient demand is only at Rs.47, for instance, the company may choose to fix Rs.47 as the Issue Price

The prices are decided by the company's board of directors , which fixes the band after consulting the bookrunner. According to SEBI Regulations, the issuer company is allowed a price band (range) of 20%. That is to say that the upper end of the price band (Rs.50 in our example) should not be more than 20% away from the lower end (Rs.45). Intellect Ltd., therefore has fixed a valid price range since the difference between Rs.50 and Rs.45 is less than 20% of Rs.45. In other words, had the price band would have been Rs.45 to Rs.60, then the same cannot be valid because 20% of Rs.45 is Rs.9, hence the maximum upper end of price band would be Rs.54, thus the valid price band has to be Rs.45 to Rs.54 per share