What is the Cut-Off Price in an IPO?

An investor may be aware of an Initial Public Offering (IPO) and its valuation, but he or she may be unaware of what constitutes the entire offering. One of the most significant parts of an IPO is the cut-off price.

What is the cut-off price in an Initial Public Offering?

A cut-off price is the price at which shares are issued to investors, which may appear to be a difficult term to a newcomer in the field of stock market investment.

An IPO book-building trouble starts with a price range, which includes both a minimum and a maximum price. An investor can bid for the desired quantity in multiples of the lot size at a price that is within the acceptable range.

There are 2 types of IPO pricing.

When it comes to IPO pricing in India, there are two types of pricing mechanisms. Let us break it down for you so you can better understand the cut-off price.

Mechanism with a Fixed Price

In a fixed-price mechanism, the IPO price is set in advance by the firm. It makes the initial public offering (IPO) open to the general public. On the day of the issuance, this mechanism declares the entire details of investors belonging to various categories. In this approach, there is no means of determining the demand for shares before the issuance date.

If the firm chooses to undertake an IPO using a Fixed-Price Mechanism, SEBI regulations mandate it to set aside 50% of total shares for retail investors.

Book Building Method

The IPO price is not determined at the start of the book-building mechanism. The corporation announces price ranges when it launches an IPO. Investors bid using a price range that falls between these pricing bands.

The issuer is expected to identify the price band or a floor price in the red herring prospectus in the case of a book building method.

The “Cut off price” refers to the actual identified issue price, which might be any price within the price band or any price over the floor price.

After examining the book and investors’ desire for the shares, the issuer comes to a decision. Only retail individual investors are allowed to apply at the cut-off price, according to SEBI regulation.

Let’s understand it with an example.

For instance, if an IPO’s price range is Rs. 200 to Rs. 210, you can apply for 10 shares at Rs. 205.  Since you were willing to subscribe to the issue up to Rs. 205, you will be allotted shares at Rs. 202 if the decided issue price is Rs. 202.

However, if the decided issue price is Rs.206, you would not be eligible for a share allotment. If you choose cut-off, you will be eligible for allotment at any issue price.

What is the role of the cut-off price in IPO?

When an IPO is approaching the end of its closure, investment bankers begin the process of price discovery. However, because no set price has been established, there are a variety of bids that occur at various values.

The bankers decide on the final price by taking a weighted average of all the offers received. The cut-off price is the ultimate price that is established. The cut-off price is usually the ceiling price in the event of popular issues that generate bids in excess of the number of shares on offer.

After the Cut-Off price has been set,

Investors who placed bids below the cut-off price will be reimbursed their whole money since they will not be allotted the IPO now that we have reached the last leg and the cut-off price has been set.

Those that placed bids over the cut-off price and received allocation are also reimbursed the excess difference.

If an investor wishes to acquire an IPO at any cost, they must choose the option to buy at cut-off while filling out the application. This ensures that the person remains eligible for the allocation regardless of the cut-off price.

Takeaway

Probably all companies use a book-building method to set the cut-off price of their shares in the current market. This strategy has shown to be adaptable, efficient, and effective in the majority of circumstances.