What is a multi-round auction?

Written by Richard Kimber

5 Jul, 2022

Starting with the basics, a multi-round auction is how it sounds: an auction that takes place over multiple rounds. Why do this? Because it’s the best way of solving most of the problems inherent in traditional auction methods.

You’re probably familiar with the two most common forms of traditional auction: Dutch (price-descending) and English (price-descending). Neither of these is suitable for a transaction as complex as share issuance.

In either a traditional Dutch or English auction there are many problems; for example, winner’s curse: the winning bidder has valued the asset higher than all other bidders, so by definition they’ve overpaid, since they’ve outbid market consensus.

There are other problems and concepts from game theory that are integral to designing a pricing and allocation process that actually works for issuer and investor: information asymmetry, free-riding, signalling, alignment of interests. A SquareBook multi-round auction (MRA) addresses all of these.

A quick-and-dirty example of a multi-round auction

Here’s a quick, heavily simplified walkthrough what an MRA can look like:

Round 1: Identifying anchors

invite several institutions you’d like as long-term holders to do due diligence, value your shares and submit non-binding bids. In return, winners get a guaranteed allocation and 10% discount on final IPO price. Three highest bidders win. Price range is set between first and fifth place. Everyone else can bid again in round 2.

Round 2: Price competition

Invite a larger group of institutions with interests aligned to yours; more prospective long-term holders. Highest 10 bidders meeting certain conditions (e.g. minimum size of allocation requested) win a smaller guaranteed allocation and a 2% discount on IPO price. Competitive bidding establishes clearing price, increases demand, and builds further momentum. IPO price is second-highest bid.

Round 3: Final demand

Open your offer to any institutions you like, and retail investors. If you’re a B2C brand, offer perks or discounts for loyal customers

Some questions

Why do anchors get a 10% discount?

Fair does not always mean equal. And not all investors are equal. Some have vast resources and expertise, and large amounts of capital. Others don’t. The ones with resources can contribute more to price discovery; if they do, that valuable work should be recognised. A 10% discount is fair recompense, and much less than the frictional cost of a pop promised in book-building, where investors are unofficially promised a discount of 20%+ anyway.

Why is IPO price the second-highest bid?

This solves the problem of winner’s curse. Detailed competitive happened before arriving here, so the second-highest bid will reflect a fair market value for the issuer without punishing the highest bidder.

This is highly simplified and there are holes, but you can also see some of the advantages already. There are lots more; for example, after round 1 you can decide not to proceed. You haven’t committed to anything – no filings, no public announcement. Just a price discovery exercise with some friendly institutions who are interested in your company. You can decide the oversubscription rate you’re aiming for in advance and structure your offer accordingly.

A key point is that everything is transparent, and the rules are published at the outset. Everyone knows how they and everyone else will be treated throughout the process.

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