What is an IPO’s Cut-Off Price?
An investor may be aware of an Initial Public Offering (IPO) and its value, but he or she may not be aware of the full scope of the offering. The cut-off price is one of the most important aspects of an IPO.
In an Initial Public Offering, what is the cut-off price?
A cut-off price is the price at which shares are issued to investors, which can be a confusing concept for someone who is new to the stock market.
A price range, which contains both a minimum and a maximum price, is the starting point for an IPO book-building problem. At a price that is within the approved range, an investor can bid for the desired quantity in multiples of the lot size.
There are two forms of initial public offering (IPO) pricing.
In India, there are two types of pricing systems for initial public offerings. Let us break it down for you so you can see how much the cut-off price is.
Mechanism with a Predetermined Cost
The IPO price is determined in advance by the firm under a fixed-price system. It allows the general public to participate in the initial public offering (IPO). This system declares the whole details of investors belonging to various groups on the day of the issuance. There is no way to predict demand for shares before the issuance date using this method.
If the company opts for a Fixed-Price Mechanism IPO, SEBI laws require it to set aside 50% of the total shares for retail investors.
Book Building Method
The IPO price is not set when the book-building mechanism begins. When a company goes public, it announces pricing ranges. Investors submit bids based on a price range that falls between these bands.
In the case of a book building approach, the issuer is expected to identify the price band or a floor price in the red herring prospectus.
The “cut off price” refers to the actual identified issue price, which could be any price within or above the floor price.
The issuer makes a judgement after reviewing the book and the demand for the shares. According to SEBI regulations, only retail individual investors are permitted to apply at the cut-off price.
Let’s have a look at an example.
If the price range for an IPO is Rs. 200 to Rs. 210, for example, you can apply for 10 shares at Rs. 205. If the decided issue price is Rs. 202, you will be given shares at Rs. 202 because you were willing to subscribe to the issue up to Rs. 205.
You would not be eligible for a share allotment if the decided issue price is Rs.206. You will be eligible for allotment at any issue price if you select cut-off.
What function does the cut-off price play in an IPO?
When an IPO’s closing date approaches, investment bankers start the price discovery process. However, because no fixed price has been specified, there are a wide range of bids at varied prices.
The final price is determined by the bankers using a weighted average of all the proposals received. The cut-off price is the final price that has been determined. In the case of popular issues with bids exceeding the number of shares on sale, the cut-off price is normally the ceiling price.
Investors who submitted bids below the cut-off price will be repaid their whole investment after the cut-off price is set, as they will not be allotted the IPO now that we have reached the final leg and the cut-off price has been set.
Those that submitted bids that were more than the cut-off price and obtained allocation will be paid the difference.
When filling out the application, if an investor wants to buy an IPO at any cost, they must select the option to buy at cut-off. This ensures that the individual is still eligible for the allocation regardless of the circumstances.
Takeaway
Almost all corporations employ a book-building process to determine the current market cut-off price for their shares. In the majority of situations, this method has proven to be adaptive, efficient, and effective.
