What is Cut-Off Price in IPO?

A cut-off price in IPO represents the final price at which shares are allocated to investors during an initial public offering. This price is determined through a systematic bidding process where investors submit their applications within a specified price band. The issuing company, along with merchant bankers and lead managers, analyses the demand at various price points to come at the cut-off price. Investors who bid at or above this price usually become eligible for share allotment, whilst those bidding below it often do not receive shares. This article explains what is cut off price in IPO, the calculation process, influencing factors, and why investors often choose this option. 

Formula for Cut-Off Price: 

Cut-Off Price = Lowest Price P where Σ (Demand at bids ≥ P) ≥ Total Shares Offered 

This formula helps identify the minimum price at which the cumulative demand equals or exceeds the total number of shares being offered. 

Steps to Calculate IPO Cut-Off Price 

The cut-off price in IPO is determined through a systematic calculation process that ensures fair price discovery based on investor demand. Here are the steps usually used for calculating the IPO cut-off price: 

Step 1: Bids Collection  

Once the IPO opens for subscription, investors submit their bids at various price levels within the specified price band. Each bid indicates the price an investor is willing to pay and the quantity of shares desired. 

Step 2: Consolidation of Demand 

After the IPO subscription period closes, all received bids are grouped according to their respective price points. This aggregation helps assess overall investor demand at different price levels across the price band. 

Step 3: Matching Price with Available Shares 

The issuing entity, merchant banker, and lead manager analyse the aggregated data to determine the price point at which the entire number of available equity shares can be allocated. This involves matching the cumulative demand with the total supply of shares. 

Step 4: Declaration of Final Price 

The identified price is declared as the cut-off price. All investors who submitted bids at or above this price usually become eligible for share allotment based on the allocation methodology. Investors whose bids fall below the cut-off price are often automatically considered ineligible, and their application fund is refunded to their accounts. 

Example of Cut-Off Price in an Upcoming IPO 

Understanding cut-off price in upcoming IPO using hypothetical scenarios. This may help clarify how the cut-off price mechanism works in real IPO applications. 

• Suppose an IPO is launched with a price band of ₹80 to ₹90. 
• An investor places a bid at ₹82, indicating willingness to buy shares only up to that price. 
• If the final cut-off price is decided at ₹81, the investor may receive allotment at ₹81. 
• However, if the cut-off price is fixed at ₹86, the bid at ₹82 is generally not eligible for allotment. 
• If the investor had opted for the cut-off price option, shares could be allotted at the final issue price, irrespective of where it is set within the band. 

Types of IPO Pricing in India  

In India, initial public offerings (IPOs) can be priced using various methods. Since the IPO cut off price meaning is understood let's look at the common types of IPO pricing methods in India: 

• Fixed Price Method 
  Under this method, the issuer company and its underwriters fix a specific price at which the shares will be offered to the public. This price remains constant throughout the offer period. Investors then apply for shares at a fixed price. 
• Book Building Method 
  This method involves a price discovery process where investors bid for shares within a price range specified by the issuer. The final offer price is determined based on the demand generated during the bidding period. This method enables price discovery based on market demand. 

IPO Tips: By keeping an eye on the upcoming IPO and reviewing data from closed IPOs, investors can gain valuable insights and make more strategic investment choices. 

Factors Affecting Cut-Off Prices in IPOs 

Understanding cut off price in IPO means recognising the various elements that influence its determination during the price discovery process. 

• Investor Interest: Higher interest from investors can often push the cut-off price towards the upper end of the price band. Typically, when investor’s enthusiasm is strong, companies may set higher prices to reflect demand. 
• Company Fundamental: Companies with stable financials, clear business models, or recognised brands generally attract higher demand. Strong fundamentals may lead to higher investor confidence, which often reflects in a cut-off price closer to the upper limit. 
• Prevailing Market Scenario: The current market conditions may significantly affect investor participation. Positive or stable markets could encourage more bids, while bearish sentiment may reduce demand, which can influence the cut-off price. 
• Level of Subscription: The level of subscription can typically determine the final cut-off. IPOs that are heavily oversubscribed usually see the cut-off price set at the higher end, whereas moderately subscribed issues may result in a lower cut-off price. 

Significance of Cut-Off Price in an IPO  

In an Initial Public Offering (IPO), the "cut-off price" is crucial, especially in IPOs. Here is why it is significant: 

• Determining the Offer Price: In a book-building IPO, the issuer does not fix the price beforehand. Instead, they provide a price range within which investors can bid for shares. The cut-off price is the final price at which shares are allocated based on investor bids. It is usually the price at which the maximum number of shares can be sold. 
• Price Discovery: The cut-off price plays an essential role in the price discovery process. It reflects the equilibrium point where demand matches supply and is determined based on various factors such as investor demand, market conditions, company fundamentals, and price sensitivity. 
• Allocation of Shares: Investors who bid at or above the cut-off price are usually allocated shares, while those who bid below it may or may not receive any shares, depending on the oversubscription level. This ensures fair distribution of shares. 
• Price Stability: Setting the cut-off price at an appropriate level is significant for maintaining price stability. If the cut-off price is too high, it may lead to a significant price drop post-listing as investors may sell off their shares. On the contrary, if it is too low, it may result in missing out on revenue opportunities for the issuer. 

Why Select the Cut-Off Price? 

Investors often choose the cut-off price option when applying for IPOs due to several strategic advantages it offers. 

1. Price Discovery Support: Cut-off bids help the issuer and market intermediaries assess true demand levels. 
2. Higher Allocation Probability: Opting for the cut-off price may increase the likelihood of allotment, especially in oversubscribed issues. 
3. Pricing Flexibility: If the final issue price is lower, investors who selected the cut-off price are generally allotted shares at the lower price. 
4. Fair Allocation Mechanism: It ensures that shares are allocated based on aggregated demand rather than arbitrary pricing. 
5. Simplified Bidding Process: Investors do not need to decide an exact bid price within the band, making the application process easier. 
6. Investor Guidance: For retail participants with limited pricing insights, the cut-off option often serves as a practical choice. 

Increasing Chances of Shares Allotment 

Individuals may deploy the following strategies to boost their chances of getting an allocation. 

• Multiple Application Channels: Investors have the option to submit applications through various channels, including savings and Demat accounts. Additionally, they can apply on behalf of family members, thereby potentially enhancing the likelihood of allocation. However, it is imperative to strictly adhere to SEBI rules and regulations during this process. 
• Bidding at a Higher Price: In instances where the final price surpasses the cut-off price, placing bids at a price exceeding the cut-off may enhance the probability of securing shares. 
• Early Application Submission: It is always a smart move to submit the IPO application right when it opens. 

Disclaimer: All investments are subject to market risks, economic conditions, regulatory changes, and other external factors. Returns are not guaranteed and may vary based on market performance and investment tenure. Investors should assess their risk tolerance and financial objectives, conduct their own research, and consult a qualified financial advisor before making any investment decisions. 

Conclusion 

Understanding the cut-off price in IPO helps investors make informed decisions during the application process. This price, determined through systematic demand analysis, ensures fair allocation based on investor interest across the price band. Factors such as market conditions, company fundamentals, and subscription levels significantly influence the final cut-off price. Selecting the cut-off price option often increases allocation probability whilst simplifying the bidding process. Investors can conveniently track IPO applications, cut-off prices, and allotment status through a reliable trading app, which provides real-time updates and facilitates seamless participation in primary market offerings. A proper understanding of this mechanism enhances the overall IPO investment experience.