What is Cut-Off Price in IPO?

Certainly, understanding the term “cut-off price” is important for investors when participating in an Initial Public Offering (IPO). The cut-off price plays a significant role in the IPO subscription process. Here’s what you need to know: Upcoming IPOs

Defining Cut-Off Price in IPO

The information you’ve provided is not entirely accurate regarding the cut-off price in an IPO. Let’s clarify the key points:

1. Cut-Off Price: The cut-off price in an IPO is not the price at which a company issues its shares to investors. Instead, it’s a price-setting mechanism that allows investors to apply for shares without specifying a particular bid price. Investors who choose the cut-off option agree to accept shares at the final price determined by the company or underwriters based on the demand generated during the IPO subscription period.
2. Price Band: In an IPO, there is typically a price band, which consists of a lower price (floor price) and an upper price (cap price). Investors can place bids within this price range or choose to apply at the cut-off price.
3. Cut-Off Price Option: The cut-off price option is primarily available to retail investors. Retail investors can apply for shares at the cut-off price, allowing them to participate in the IPO without specifying a particular bid price. However, other categories of investors, such as Qualified Institutional Buyers (QIBs) and Non-Institutional Investors (NIIs), must specify their bid prices within the price band.
4. Allotment: Allotment of shares at the cut-off price is subject to availability. If the IPO is oversubscribed in the retail category, there is no guarantee that all retail investors who applied at the cut-off price will receive the full quantity of shares they requested. Allocation is typically done on a pro-rata basis.
5. Final Price Determination: The final issue price is determined based on the demand generated during the IPO subscription period. It may fall within or outside the price band. The company and underwriters consider various factors, including investor demand, market conditions, and regulatory requirements when setting the final price.
6. Example Clarification: In your example, if you apply for five shares at a price of Rs.210 and the final issue price determined by the company is Rs. 215, you will not get the share allotment, regardless of whether you applied at the cut-off price or a specific bid price. Applying at the cut-off price does not guarantee that you will receive shares if the issue price exceeds your specified limit.

Types of IPO Pricing in India

Two different types of IPO pricing mechanisms in India is generally accurate. Here’s a more detailed explanation of these two methods:

1. Fixed Price Mechanism:

• Pricing: Under the fixed price mechanism, the company sets a specific price at which the shares will be offered to the public well in advance of the IPO. This price is known as the “offer price” or “issue price.”
• Price Disclosure: The offer price is disclosed in the IPO prospectus, which is made available to investors when the IPO is launched. Investors know the exact price at which they can subscribe to the IPO.
• Demand Assessment: With the fixed price method, there is no opportunity to assess investor demand or set a price range before the IPO. The company and underwriters rely on their assessment of market conditions and investor interest to determine the fixed price.
• Retail Allocation: As per SEBI regulations, a minimum of 35% of the shares in the IPO must be reserved for retail investors. However, it is not mandated that 50% must be allotted to retail investors; this allocation percentage can vary depending on the company’s decision.

2. Book Building Method:

• Pricing: In the book building method, the company does not determine the IPO price at the outset. Instead, it discloses a price range, which consists of a floor price (the minimum price) and a cap price (the maximum price).
• Price Discovery: Investors, including retail investors, then place bids within this price range. The demand for shares is recorded at various price points.
• Price Determination: The final issue price is determined based on the demand generated during the IPO subscription period. It is typically set at a price where the demand is highest, ensuring that the IPO is well-received in the market.
• Retail Allocation: Similar to the fixed price method, SEBI regulations mandate a minimum of 35% of the shares to be reserved for retail investors. However, the allocation percentage can vary, and it depends on the company’s decision and market conditions.

Both pricing mechanisms have their advantages and drawbacks. The book-building method allows for better price discovery and can lead to more accurate pricing based on market demand. The fixed price mechanism provides simplicity and transparency but may not capture market dynamics as effectively. The choice of pricing method depends on the company’s goals and market conditions at the time of the IPO.

How to improve the chances of allotment?

During the IPO application process, investors have the option to choose the “cut-off price” as their preferred price. Opting for the cut-off price essentially implies that the investor is willing to accept whatever price the company and its Book Running Lead Managers determine as the final issue price after the IPO subscription period ends. Selecting the cut-off price when submitting your IPO application can potentially enhance your chances of receiving an allotment of IPO shares.

What happens if you bid lower or higher than the cut-off price in an IPO? 

If your bid price in an IPO is lower than the cut-off price established by the company, you will indeed be automatically disqualified from receiving an allotment of shares. On the other hand, if you bid higher than the cut-off price, the excess amount you paid will be refunded to you after the allotment process is completed. This ensures that you are only charged the final issue price determined by the company, even if your bid was higher during the application process.

Should we bid at the cut-off price?

If you choose to bid at the cut-off price in an IPO, you can enhance your likelihood of receiving a share allotment. It simplifies the application process and aligns your bid with the final price determined by the company and its Book Running Lead Managers.

It’s essential to note that if you bid at or below the final price, you may not receive an allotment, and your application may be rejected. However, if your bid exceeds the final price, the excess amount you paid will be refunded to you after the allotment process.

Is IPO first come, first serve?

You are correct; the allotment of IPO shares in India does not follow a “first come, first served” methodology. Instead, it depends on various factors, primarily the response the IPO receives from investors during the subscription period. Here’s a more detailed explanation:

1. Oversubscription: If an IPO is oversubscribed, meaning that the total number of shares applied for by investors exceeds the number of shares available for allotment, the allocation process becomes competitive. In such cases, the company and its underwriters use a proportionate allotment method to distribute shares among investors. Each investor’s allotment is based on the ratio of their applied shares to the total demand in that category.
2. Undersubscription: When an IPO is undersubscribed, which means that the demand for shares is less than the number of shares available, investors have a higher likelihood of receiving the full quantity of shares they applied for. In such cases, the allotment process is less competitive, and there may be a higher chance of getting all applied lots.
3. Lottery System: In situations where the IPO is heavily oversubscribed, a lottery system may be employed for retail investors to ensure fairness. Under this system, all eligible applicants have an equal chance of receiving shares, regardless of the size of their application. This approach aims to provide equal opportunities to small and large investors alike.
4. Employee and Employee Discount Categories: In some IPOs, there may be a separate category reserved for employees and eligible employees who receive a discount on the IPO price. The allocation to these categories may follow specific criteria outlined by the company.

Conclusion

Now that you have a clear understanding what the cut-off price in an IPO is. So, the next time you apply for an upcoming IPO, make sure to select the ‘cut-off price’ option before submitting your application rewrite same maner