Understanding What Is The Cut Off Price In IPO: An initial public offering is a process that helps an organization make a public offer to investors for the first time to attract investment. In this case, trade is between investors and the original issuer.
Investors are required to get familiar with the terminologies used during the IPO. For example, price band, floor price, issue price, cut-off price, etc. are some of the basic terms which are used when the companies are out with their IPOs.
The price band is the range within which investors are allowed to bid for IPO shares. This range is jointly set by the company and underwriter. In this article, we will understand what is the cut off price in IPO and what is its importance.
What Is The Cut Off Price In IPO?
You might have heard “cut-off price” when companies are out with their IPOs. This is an essential aspect of IPO. The cut-off price is the price at which investors can get shares.
The company finalizes the price once consultations are done with book-running lead managers (BRLMs). The cut-off price in an IPO can be any price within the price band. Investors are required to be aware that this price is different from the floor price.
A floor price is a price at which minimum bids can be made. According to SEBI’s guidelines, retail individual investors are eligible to apply at the cut-off price. Simply put, the cut-off price means the offer price at which shares can be issued to the investors.
IPO book building issue starts with a price range. Every investor is allowed to place bids for desired quantity and in multiples of the lot size. Choosing a cut-off option at the time of applying for the issue exhibits an investor’s willingness to subscribe at any price which can be discovered within the price band through the book-building process.
This eventually increases the chances of getting the IPO allotment. Basically, if an investor selects a cut-off, that investor becomes eligible for allotment at any issued price which can be discovered.
Types Of IPO Pricing In India
To understand what is the cut-off price in an IPO, it is important to understand 2 types of pricing mechanisms that are adopted in India. We have broken it down so that types can be understood in a better way.
1. Mechanism with Fixed Price
In a fixed-price mechanism, the price of the IPO is decided in advance by an organization. It makes an IPO available to the general public. At the time of issuance, this sort of mechanism declares the entire details of investors and the categories they belong to.
In a fixed-price mechanism, there is no requirement of determining a demand for the shares before the issuance date. If the firm decided to go ahead with a Fixed-Price Mechanism, SEBI has mandated that it should set aside 50% of total shares only for retail investors.
2. Book Building Method
In the book-building method, IPO pricing is not determined at the start. In this method, the company announces price ranges at the time of launching an IPO. Later on, investors tend to bid with the help of a price range that falls between pricing bands.
In a book-building method, the issuer needs to identify the price band or a floor price in its red herring prospectus. “Cut-off price” is referred to the actual identified issue price. This can be any price within the announced price range or any price which is higher than the floor price.
After monitoring the book and the desire of investors for the shares, the issuer reaches a decision. However, only the retail category of individual investors can apply at the cut-off price, as per the SEBI rules. Let us understand this method with the help of an example.
If the price range of an IPO has been set at INR300-INR310, an investor can apply for 10 shares (and in multiples) at any price between this range. Let us consider that he chooses INR305. This means that the investor is willing to pay a maximum of INR305 per share.
Therefore, if the decided issue price is less than INR305, he will be allotted the shares. However, if the decided price is higher than INR305, he will not be eligible for an allotment. Therefore, it is advised to choose a cut-off price as this makes an investor eligible for allotment at any issued price.
Role Of Cut-Off Price In IPO
Now that we know what is the cut off price in IPO, it is now time to understand the role of the cut-off price. When an IPO nears its closure, investment bankers tend to start the process of price discovery. However, since a set price has not been established, there are several bids that occur at different values.
How is cut off price calculated?
Investment bankers decide the final price by considering a weighted average of all the offers received. The cut-off price is usually called the ceiling price when the IPOs are quite popular. These IPOs generate bids higher than the number of shares on offer.
Should we bid IPO at cut off price
After the cut-off price has been set, investors who decide to place their bids below the cut-off price will get their money back. This is because the IPO will not be allotted to them. Investors who have placed their bids higher than the cut-off price and got the allocation will be reimbursed for the excess difference.
If an investor believes in the financial position of the company and he/she intends to acquire an IPO at any cost, they are required to choose the option to buy at the cut-off when they fill out an application form. This helps in ensuring that a person is eligible regardless of the cut-off price.
Also Read: What is an IPO (Initial Public Offering) & How Does it Work?
To Sum Up
We hope the most common question, “what is the cut-off price in an IPO,” has been answered. Nowadays, most companies decide to go for a book-building method to set the cut-off price of their shares. Book-building method has exhibited adaptability, efficiency, and effectiveness in several circumstances.
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