In an IPO, the price at which a company issues its shares to investors is referred to as the "cut-off price." The company decides it after analysing the demands of the investors for the shares. It is the actual issue price, which might be any amount within the specified price range. Only individual retail investors may submit an application for an IPO at the cut-off price in accordance with SEBI regulations.
Instead of a set price method, this is typically involved in a book-building issue. In its prospectus, the company specifies the price range or floor price. The actual price is either above the floor price or within the price range.
Let's take an illustration to understand the cut-off price in an IPO. Let's say that the pricing range for the IPO of company 'A' is between Rs. 80 and Rs. 90. Ten shares are available for application at the cost of Rs. 85. Suppose you want to subscribe at a price of up to Rs. 81. You will get the share at Rs. 81 if it is the set issue price.
However, if the issue's final price is Rs. 86, you will not be allocated any shares. If you follow the cut-off, you will receive shares at any issue price.
There are two main kinds of IPO pricing processes in India. They include the following.
Fixed Price Mechanism
In this system, the company determines the IPO price in advance. The IPO becomes public at this price. This mechanism reveals the information about investors on the day of issuance. Before the day of issuance, there is no way to gauge demand for shares. As a result, the Securities and Exchange Board of India (SEBI) has ordered that 50% of the total share lot be allocated to retail investors when a firm opts to use the fixed pricing mechanism.
Book Building Method
In this method, the IPO price is not set at the start of the book-building process. Companies announce the price range when they launch the IPO. Investors then start bidding in these pricing bands. It is the issuer's obligation to specify this floor price or the price range in the red herring prospectus.
Let's now explore the relevance of Cut-Off Price.
The Cut-Off Price Discovery: The final price at which investors will get their shares is heavily influenced by the cut-off price. It's a component of the price discovery mechanism. The demand for shares at various price levels is sometimes taken into account when determining the final issue price.
Promotes Fairness: Establishing a cut-off price ensures transparency in the allotment of shares. Investors who place a bid at or above the cut-off price in an IPO have a better chance of getting shares. Those who place an offer below it may only get a partial or no allocation.
Minimum Investment: Investors can use the cut-off price as a reference to figure out how much money they must invest in the IPO. It aids investors in determining the least amount of shares they can purchase.
Price Stability: The cut-off price helps a company and its underwriters ensure price stability after the stock starts trading on the secondary market. This price floor helps in preventing speculative trading and aggressive underpricing.
Investors can submit a bid at the cut-off price in IPO or a higher price within the price range. If there is a shortage of shares, allocation is done by a lottery. However, if the final price is greater than the cut-off, placing a larger offer improves the chances of share allotment. Let's take an example to understand this better. Suppose a company ‘X’ wants to issue an initial public offering. The price range for shares is Rs. 100 to Rs. 120.
Retail Investor P offers 200 sharesIA bids for 100 shares at a price of 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 at a price of Rs. 100 each.
The company's book-building procedure receives bids from institutional and retail investors. The shares can be allotted at a maximum price equal to the cut-off price. Assume that Rs. 110 per share is chosen as the cut-off price.
At the cut-off price, investor A, who placed a bid of Rs. 110, will get 100 shares. Investor B will also receive 100 shares at Rs. 110 after placing a bid of Rs. 105. Investor C, who placed a bid of Rs. 115, will be allotted 25 shares. He will receive the shares first. If there are more bidders than the quantity of shares available at the cut-off price, investor D, who is bidding at Rs. 100, may not get any shares. The cut-off price in IPO aligns the company's value expectations with market demand. It also ensures fairness in share distribution.
If an investor bids less than the highest possible price in an oversubscribed IPO, they have no chance of receiving an allocation. The chances of allocation remain modest even after choosing the higher end of the pricing range. This is especially true for popular IPOs. You may use the following strategies to improve your chances of getting an allocation.
Making Multiple Applications: Investors may submit applications through different channels (such as savings and demat accounts). They can also apply in the names of their family members. This increases the likelihood of allocation. However, one must be careful to adhere to SEBI rules.
Applying at a greater Price: If the final price is greater than the cut-off, bidding at a price higher than the cut-off might increase the chances of getting shares.
Applying on the first day: It is best to apply for an IPO as soon as it begins. Reputed firms like Kotak Securities provide a simple IPO application procedure. So you can apply for an IPO swiftly.
The price at which a company issues its shares in an IPO is the cut-off price. The allocation of shares to investors and the final offer price of the shares are both determined by the cut-off price. It is an important factor in the list of IPOs. The calculation of cut-off price depends on a number of variables. These include supply and demand in the market, a company's fundamentals, and other market circumstances. To make wise investment choices, it is crucial for investors to comprehend the idea of cut-off price and its significance in IPOs.
Retail investors, employees bidding under the employee reservation portion, and shareholders bidding under the shareholders' reserve portion can apply at the cut-off price (provided the bid amount is up to Rs 200,000).
Qualified institutional bidders (QIB), non-institutional bidders (NII), anchor investors, or shareholders placing bids under the shareholders' reservation component for more than Rs 200,000 cannot apply for an IPO at the cut-off price.
The cut-off price is jointly decided by the company launching the IPO and its underwriters. They take into account investor demand and set the final issue price, which is often close to the cut-off price.
Yes, you can place a bid above the cut-off price. The highest priority price is used to determine the allocation in an Offer for Sale (OFS).
The main danger of using the cut-off price is that the actual IPO price can be greater than anticipated. Investors need to be ready for the prospect of a higher share price.
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