What is Cut-Off Price in IPO?

In an Initial Public Offering (IPO), the cut-off price refers to the price at or above which shares will be allocated to investors. When a company decides to go public and issue shares for the first time, it sets a price range for those shares. Investors then place bids indicating the number of shares they want and the price they are willing to pay. 

The cut-off price is determined based on the demand for shares at various prices. It is usually set at the price level where the number of shares demanded by investors matches the number of shares being offered by the company. In other words, it is the highest price at which all shares offered can be sold. Investors who bid at or above the cut-off price usually receive shares, while those who bid below it may not receive any shares or might only receive a portion of what they bid for, depending on the IPO.

Example of Cut-off price in an upcoming IPO

Let us consider an example of the cut-off price in an Initial Public Offering (IPO) context.

IPO Price Range: Rs. 80/- to Rs. 90/- per share

Your Preferred Price: Rs. 81/- per share

Now, let's consider two possibilities for the final issue price:

Scenario 1: Final Issue Price is Rs. 81/- per share

Since the final issue price aligns with your preference, you will be allocated shares at this price.

You will buy shares at Rs. 81/- per share.

Scenario 2: Final Issue Price is Rs. 86/- per share

The final issue price exceeds your specified limit of Rs. 81/- per share.

As a result, you will not be allocated any shares under your preferred price limit.

Summary:

If the final issue price is Rs. 81/- per share or lower, you will be allocated shares at that price.

If the final issue price exceeds Rs. 81/- per share, you will not be allocated any shares.

Types of IPO Pricing in India 

In India, initial public offerings (IPOs) can be priced using various methods. Here are 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.

Offer for Sale (OFS): 

In this method, the existing shareholders of the company, such as promoters or other investors, sell their shares directly to the public. The company does not issue new shares, and the proceeds from the sale go to the selling shareholders.

Rights Issue:

A rights issue is an offer made by a listed company to its existing shareholders to purchase additional shares at a discounted price, usually in proportion to their existing holdings. The price at which these additional shares are offered is fixed by the company.

Qualified Institutional Placement (QIP): 

This method is utilized by listed companies to raise funds by issuing equity shares or convertible securities to qualified institutional buyers (QIBs) without the need for a public offering. The pricing of shares in QIP is usually determined through negotiations between the company and the investors.
The choice of IPO pricing method depends on various factors such as market sentiment, company valuation, regulatory requirements, and investor 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. 

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. 

Selecting Cut-off Price while Applying

Investors have the option to submit bids at either the cut-off price specified in the IPO or at a higher price within the designated price range. In scenarios, where there is scarcity of shares, allocation is determined through a lottery system. However, in instances where the final price exceeds the cut-off, submitting a higher bid increases the likelihood of share allotment. To illustrate, let us consider the scenario of a company, 'X', intending to launch an initial public offering. The proposed price range for shares is between Rs. 100 and Rs. 120.

• Retail Investor P offer 200 shares bids of 100 shares for Rs. 110/- each
• Investor B offers Rs. 105/- per share for 50 shares
• At Rs. 115/- per share, retail investor C makes an offer for 25 shares
• Retail Investor D makes a bid for 200 shares for Rs. 100/- each

Consider that Rs. 110 per share is selected as the cut-off price.  At the determined cut-off price, Investor A, having placed a bid of Rs. 110, will acquire 100 shares, while Investor B, whose bid stands at Rs. 105, will similarly secure 100 shares at Rs. 110. Investor C, who submitted a bid of Rs. 115, will be allocated 25 shares. In instances, where the number of bidders exceeds the available share quantity at the cut-off price, Investor D, bidding at Rs. 100, may not be liable for getting any shares. 

Increasing Chances of Shares Allotment

You may deploy the following strategies to boost your 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 your IPO application right when it kicks off.

Conclusion
The definition of the cut-off price in an IPO serves as a crucial factor for the success of an IPO. It represents a subtle balance between issuer and investor, playing a vital role in shaping the performance and long-term financial journey of a company in the public market.