What Is The Cut-Off Price in an IPO?

An initial public offering (IPO) is beneficial for both the issuing company and the investors. For example, the issuing company gets access to funds, which can be used to further its business. Investors, meanwhile, get a chance to become part of a company’s growth story right from the beginning. If the company does well, its share prices will rise and increase investors’ wealth.

If you are an investor who wishes to invest in an IPO, you must be familiar with the various terms used. In this comprehensive guide, we are going to explore one such term – the cut-off price – in detail. Additionally, we will also look into why the cut-off price matters and how it affects your investment.

What is the Cut-Off Price in an IPO? 

The cut-off price is the final price at which the equity shares are allotted to the investors of an initial public offering. When companies launch an IPO, they usually announce a price band. Interested investors can place bids for the company’s shares at any price within the announced band.

The cut-off price or the final issue price for the IPO is determined after considering all bids from various investors. Investors with bids at or above the cut-off price are only considered eligible for share allotment. Meanwhile, investors whose bids are lower than the cut-off price are deemed ineligible and their application money is refunded.

How Does the Cut-Off Price Work?

Let us try to understand the concept of the cut-off price in an IPO with the help of a hypothetical example.

Assume a company comes out with an IPO where it plans to issue 1 lakh equity shares. The price band of the issue is ₹200 to ₹210 per share. Different investors submit bids at various prices within this range. Once the bidding closes, the company evaluates all bids and identifies the highest price at which the total shares offered can be sold, which becomes the cut-off price.

Now, let us assume that you applied for 10 equity shares at a price of ₹207 per share. The cut-off price that was determined is ₹210 per share. Since your bid is lower than the cut-off price, you will be deemed ineligible for share allotment.

On the other hand, had you selected the ‘cut-off price’ option when applying for the IPO or placed your bid at the highest price level, you would have been eligible for share allotment.

Types of IPO Pricing Strategies and Their Cut-Off Prices

Companies can price their initial public offerings in either of two ways – fixed pricing or book-building. Here is a quick overview of each of these two types and how the cut-off price is determined.

• Fixed Pricing 

In a fixed-price IPO, the company sets a fixed price for its shares well in advance. Since investors know the exact price before applying, the concept of cut-off price does not apply to this IPO pricing strategy. The price at which the shares are offered is the price at which shares will be allotted to the investors.

• Book Building 

In a book-built IPO, the company provides a price band. Investors can place their bids within this range. After the bidding process is complete, the cut-off price is determined based on a multitude of different factors. Once the cut-off price is determined, the shares are issued at this price to the investors.

How is the Cut-Off Price Calculated?

The cut-off price is not an arbitrary figure. In fact, it is calculated systematically by the issuing company, the merchant banker and the lead manager. Here is a quick overview of the step-by-step process through which the cut-off price is determined.

• Step 1: Collection of Bids

Once the issue opens, investors submit bids at various price levels within the price band.

• Step 2: Demand Aggregation

Once the issue closes, all of the bids are grouped based on price points to assess investor demand.

• Step 3: Price-Volume Matching

The price at which the issuing entity can sell the entire number of available equity shares is determined.

• Step 4: Finalisation

This price is then declared as the cut-off price. All investors with bids at or above the cut-off price are deemed eligible for share allotment. Investors whose bids are below the cut-off price are automatically deemed ineligible, and their application money is refunded.

Factors that Influence the Cut-Off Price for an IPO

The final cut-off price for an IPO is influenced by a plethora of different factors. Here is a brief overview of some of the key factors.

• Investor Demand

The most important factor that influences the cut-off price for an IPO is investor demand. If the demand for shares is high, the cut-off price is often pushed toward the higher end of the price band.

• Market Conditions

The prevailing market conditions also play a major role in determining the cut-off price. For instance, bullish markets often lead to higher investor demand and enthusiasm, which in turn leads to higher cut-off prices.

• Company Fundamentals

If the issuing entity has strong financials, robust growth prospects and brand reputation, the investor demand is likely to be quite high, which influences the cut-off price.

• Subscription Levels

If the IPO is oversubscribed, where the demand is higher than the total number of equity shares available, the cut-off price usually tends to be on the higher side.

Significance of the Cut-Off Price in an IPO

The cut-off price in an IPO is highly significant for both investors and companies. Here are a few reasons why this price is considered important.

• Fair Price Discovery

The cut-off price plays a vital role in ensuring fair price discovery during an IPO. It reflects the real demand from investors instead of arbitrary valuations or speculative market expectations. This benefits both companies and investors by creating a transparent, demand-led pricing mechanism.

• Optimised Fundraising 

The cut-off price ensures that companies raise the maximum possible capital without compromising on investor interest. By setting a price that matches the demand, companies can avoid underpricing or overpricing their shares.

• Efficient Allotment 

The use of a cut-off price simplifies the share allotment process by standardising the price point for all eligible bids. Investors who bid at or above the cut-off price are deemed eligible for share allotment. Meanwhile, investors who bid below the cut-off price are ineligible for allotment.

• Investor Confidence

The cut-off price reassures the investors that the final price of the issue is determined based on actual market demand through a transparent bidding process. This builds strong trust and confidence in the IPO process, which is vital for a healthy financial market.

Conclusion 

Understanding the cut-off price of an IPO is essential as it helps you when applying for an initial public offering. Selecting the ‘cut-off price’ option when applying for a public issue can dramatically increase your chances of securing share allotment. However, it is important to note that the ‘cut-off price’ option is only available for the retail investor category. If you are applying under other categories, this option will not be available. In this case, it is advisable to select the highest price level to increase your chances of allotment.

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