A competitive process where assets are sold to the highest bidder.
What is an auction?
An auction is a competitive process where buyers place rival bids in an attempt to purchase a wide range of assets, including artwork, property and shares.
There are different formats used to execute auctions. They include:
- Open auctions
This is where would-be buyers are kept fully informed about the bids placed by their rivals. As prices go up, they can either decide to raise their bid or withdraw themselves from consideration. A winner is declared when there is only one interested party left.
- Closed auctions
This approach is often used for business-related auctions. When a company’s assets are being auctioned, or a firm is bidding for the opportunity to win a lucrative contract, they may be requested to put in a sealed bid and a business proposal that can only be seen by the seller. From here, interested parties may be whittled down to a shortlist, and an additional round may be held. Closed auctions are often popular when the highest bid is not the only factor a seller is taking into account.
- Dutch auctions
Companies exploring initial public offerings use Dutch auctions to determine how much they can charge per share. Investors are invited to contribute sealed bids that reveal how much they would be willing to pay in exchange for a set number of shares. This term also refers to auctions that go in reverse – with the price of an asset coming down until a buyer makes a bid.
The pros and cons
Auctions can be advantageous for buyers because it can deliver the opportunity to purchase assets at a lower price. Meanwhile, sellers can protect themselves by enforcing a reserve price – the minimum amount they are willing to accept for their asset. For both parties, they can also eliminate the long and arduous negotiation periods that are often associated with big transactions.
There are also downsides that need to be taken into account. Given how open auctions normally happen at a quick pace, buyers can get carried away and end up paying far more for an asset than they would if they were thinking rationally. For certain types of auctions, such as property, it can also be much harder for buyers to complete their due diligence, as they may not even get a chance to set foot in a building before they decide whether to buy it.