What is an IPO Cut-Off Price?
A cut-off price in IPO means the price at which shares are allotted to retail investors. It represents the final amount set by the company after it has considered all bids within the given limit. By choosing a cut-off price, investors can apply for shares without determining their respective prices. As a result, increasing the chances of allotment. This technique is helpful to small-time investors in India who might prefer an easier method of participating in an IPO without having detailed knowledge about bidding procedures. In this blog, you will understand the types of cut-off prices in IPO, their significance, the selection of cut-off prices while applying, and how to improve the chances of allotment.
Key Highlights
- The cut-off price for an initial public offering is vital for ensuring fair distribution of shares for retail investors.
- Selecting the cut-off price option boosts an investor’s possibility of obtaining stocks.
- The two most common approaches used in IPO pricing are fixed-price and book-building methods.
- Applying early, bidding more, and creating multiple applications can improve the chances of share allotment.
Table of Contents
Example of IPO Cut-Off Price
Consider ABC Ltd. which will be launching an IPO. The price band for the shares was predetermined between Rs. 150 and Rs. 170.
Retail Investor P bided for 200 shares of Rs. 160 each
Retail Investor Q predetermined 100 shares with a price of Rs 155 each
Retail Investor R bidding for 50 shares at Rs 165 each
Retail Investor S requested 300 shares at Rs 150 a piece
Here, the book-building process of a company gathers bids from retail and institutional investors. The cut-off price is the price at which the number of shares that can be allocated among different investors will be maximum. Let us assume that the cut-off price has been fixed at Rs 160 for this case.
Retail Investor P who bided Rs 160 will have 200 shares allotted to him at that cut-off price.
Similarly, Retail Investor Q who placed a bid of Rs 155 will also get a 100 sold out in totality for them at Rs 160.
Therefore, the Retail Investor R will take home 50 stocks at the cut-off price.
However, Retail Investor S who placed a bid at Rs. 150 may not receive any shares if the demand surpasses the availability.
Therefore, the cut-off price ensures fairness in share distribution among shareholders and aligns company valuation with market demand.
Two Types of IPO Pricing
Two types of IPO pricing help in determining the price of the IPO. Let’s discuss them in brief:
1. Fixed Price Issue
In this method, the company predetermines the IPO price. This means that the public is offered shares at a fixed price. Moreover, information regarding investors is available only on the issuance date of shares. However, it can be difficult to assess the level of demand for shares before this time. This is why SEBI specifies that 50% of shares should be allotted to retail investors while utilising fixed priced method by any firm.
2. Book Building Issue
In this method, the IPO price is not predetermined from the beginning. Rather, when they launch an IPO, firms announce a range of prices. Then, investors place bids that fall into this range. Thus, it is up to the firm to determine the lowest price or range included in the red herring prospectus.
Significance of Cut-Off Price in IPO
The cut-off price plays a critical role in deciding how shares are distributed and ensuring fairness in an IPO. Let’s discuss the significance of cut-off price in IPO in brief:
Cut Off Price Discovery
The cut-off price is an important determinant of the final price at which investors will sell their shares. It is part of the price discovery process because during this process the issue price is determined based on the demand for shares at different price levels.
Promotes Fairness
A cut-off price is meant to guarantee a fair allotment of shares. In an IPO, investors who offer at or above the cut-off price are more likely to acquire shares. Whereas, those who offer below the price might get none or just a partial allotment.
Minimum Investment
The cut-off price aids investors in knowing the least value they can invest in the IPO. It helps them figure out the smallest number of shares they can acquire.
Pricing Stability
To keep cost volatility in check, the cut-off price aids the company and its underwriters when shares are introduced for business in the secondary market. This also cautions against speculation and over-optimistic estimates.
Selecting Cut-Off Price While Applying
Brokerages provide investors with an option called ‘cut-off’ whenever they apply for an IPO. This allows investors to show that they are willing to pay any price within the predetermined price band. Moreover, by selecting this option, investors accept any final issue price, even the maximum one mentioned in the prospectus. This can significantly increase their allotment chances if the IPOs are in demand. Thus, this option is particularly essential to people who are confident in the company and want shares within the specified price range. Whereas, if the cut-off price is not determined, investors who bid below the final price do not get any allotment of shares.
Improving The Chances of Getting An Allotment
An investor who bids less than the highest amount in an oversubscribed IPO has almost no chance of getting any shares. Even placing a bid at the highest price range might not assure you of share allocation, especially with high-demand IPOs. However, to increase your chances of being allocated some shares you can keep in mind the below-mentioned points:
Make Multiple Applications
Investors can apply via various channels, such as savings accounts and Demat accounts, or through accounts of family members. However, it increases the likelihood of obtaining shares, this must be executed within the regulations established by SEBI.
Bid at a Higher Price
If one decides to purchase at a price that is more than the cut-off price, they increase their chances of acquiring shares in case the final price goes up.
Apply Early
To increase your chances of allotment, it’s better to apply on the first day of the IPO.
Conclusion
For investors applying for initial public offerings (IPOs), understanding the cut-off price is essential. This is because share allocation and fairness in distribution are determined by the cut-off price. Moreover, by using the cut-off option, investors can increase their chances of being allocated with oversubscribed IPO shares. Furthermore, applying early, placing higher bids, and making multiple applications help improve the chances of getting any allotment. Therefore, selecting a proper method for pricing IPOs and availing of the cut-off price can improve your odds of getting stocks in a competitive environment.
FAQs on IPO Cut-Off Price
To improve their chances of obtaining IPO shares, investors apply for an IPO at the cut-off price. By doing so, they show that they are willing to pay a high amount for shares of that firm.
According to the rules set by SEBI, only qualified investors can purchase an IPO at the price cut-off.
The price at which the IPO is sold is determined by either book building or fixed price method. Under the book-building method, shares are priced according to orders received during the bidding process. For instance, if the issuer suggests a price range like Rs.75 to Rs.80, this indicates an area within which possible prices may lie.
The IPO orders can be placed from 10:00 A.M. to 4:30 P.M. Those orders placed during market times will be processed on the same day. Whereas, orders placed after 4:30 P.M. would have to wait until the next working day.
No, the cut-off price and listing price are different. The cut-off price is the price at which shares are offered to investors in an IPO and it falls within a specified price band. Whereas, the listing price is the price at which a company's shares are first traded on the stock exchange after an IPO.