Cut-Off Price

Introduction

The cut-off price is an essential term in the world of Initial Public Offerings (IPOs) and plays a critical role in how investors apply for shares during an IPO. When participating in an IPO, investors often have the option to bid at the “cut-off price,” a feature that simplifies the application process for retail investors by allowing them to agree to purchase shares at the price determined through the IPO bidding process.

This guide will delve into what the cut-off prices are, how the market determines them, their role in the IPO bidding process, and their importance for different types of investors.

What is the Cut-Off Price?

The company allots shares to investors at the cut-off prices after the bidding process concludes in an IPO. It represents the final price within the predetermined price band and is based on investor demand. Unlike a fixed price, the cut-off prices are dynamic and fluctuate based on the demand from institutional and retail investors.

In simple terms, it is the price at which the company and its underwriters agree to issue the shares to the public. For retail investors, selecting the cut-off prices while bidding ensures that the system considers them for allotment without requiring them to specify a particular price.

Why is the Cut-Off Price Important?

The cut-off prices play a critical role for several reasons:

1. Sets the Final Price for Allotment: It establishes the final price at which shares will be allocated to successful bidders in the IPO.
2. Simplifies Retail Participation: For retail individual investors, opting for the cut-off prices makes the bidding process more accessible, as they do not need to decide on specific prices within the band.
3. Maximizes Demand-Based Pricing: It enables demand-based pricing, allowing the issuer to set a price that reflects true investor interest.
4. Determines Capital Raised: The cut-off prices directly impact the funds a company raises in the IPO.

You may also want to know the Draft Prospectus

How are the Cut-Off Prices Determined in an IPO?

In the book-building IPO process, the cut-off prices are determined through a dynamic pricing model. Here’s a breakdown of the process:

1. Setting a Price Band

The company and its underwriters initially set a price band a range within which investors can bid for shares. For example, the company may set a price band between ₹100 and ₹120 per share, where ₹100 is the floor price (minimum bid) and ₹120 is the cap price (maximum bid).

2. Bidding by Investors

Investors then submit bids for shares within the price band during the IPO period. Institutional investors, high-net-worth individuals (HNIs), and retail investors can place bids at any price point within this range. Each bid includes the number of shares and the bid price.

3. Price Discovery

After the bidding period closes, the market analyzes the demand at each price level within the band. Based on demand from different investor categories, the process determines the final price. The highest price at which all shares can be sold (fully subscribed) becomes the cut-off price.

4. Finalizing the Cut-Off Price

The issuer and underwriters evaluate bids to determine the highest price point where there is sufficient demand to sell the total issue size. This final price point is set as the cut-off price, and shares are allotted to successful bidders at this price.

Cut-Off Price and Retail Individual Investors

The cut-off price option is particularly advantageous for retail individual investors (RIIs) as it simplifies their bidding process. Retail investors often lack the resources to analyze the price band and determine the ideal bid price. By selecting the cut-off prices, they agree to buy shares at the price determined after the IPO closes, which ensures that they participate in the allotment if demand allows.

• IPO Apply Time: When applying for an IPO, retail investors select the “cut-off price” option, typically available in online trading portals and broker applications.
• Retail Allotment: Retail investors are only eligible for allotment if they choose either a specific price within the band or select the cut-off prices option. Selecting a price lower than the cut-off prices reduces their chances of allotment.

Cut-Off Price in Comparison to Fixed Price Issues

In a fixed price issue, the IPO price is pre-determined and announced before the IPO opens. Investors do not need to bid within a price band and instead apply at the fixed price. The cut-off prices are a concept unique to book-built IPOs, allowing for flexible pricing based on demand.

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Fixed Price Issue vs. Cut-Off Price in Book Building

How to Bid in an IPO Using the Cut-Off Price

For retail investors, selecting the cut-off prices while bidding in an IPO is straightforward. Here’s a step-by-step guide:

1. Select IPO: Log in to your brokerage account or trading platform and choose the IPO you wish to participate in.
2. Choose Cut-Off Price Option: When filling in the bid details, select the “cut-off price” option instead of specifying a particular price within the band.
3. Specify Lot Size: Indicate the number of shares (or lots) you wish to apply for, as companies often make IPO allotments in lot sizes.
4. Submit Application: Complete the application process by submitting the bid. The system will ensure you are considered for allotment at the cut-off prices if demand allows.

By choosing the cut-off price, retail investors simplify the bidding process and increase their chances of receiving allotment if the IPO oversubscribes.

Cut-Off Price in Reverse Book Building

In addition to regular IPOs, the concept of cut-off prices is also applicable in reverse book building. Companies use this process when they wish to buy back shares from the public or exit from the stock exchange. In reverse book building, the cut-off prices represent the highest price at which shareholders are willing to sell their shares back to the company.

Cut-Off Time for IPO Applications and Mutual Fund Purchases

The cut-off time is another critical concept related to the cut-off prices, especially for mutual funds and IPO applications:

1. IPO Cut-Off Time: The company usually sets the cut-off time for submitting IPO applications at the end of the last day of the IPO subscription period. Applications submitted after the cut-off time may not be eligible.
2. Mutual Fund Cut-Off Time: In mutual fund investments, the cut-off time determines the Net Asset Value (NAV) at which the fund allocates an investor’s units. Mutual fund cut-off times vary based on the fund type (equity, debt) and transaction time.

Importance of Cut-Off Price for Investors

The cut-off prices are beneficial to investors for various reasons:

1. Reduces Risk for Retail Investors: Retail investors avoid the risk of mispricing by selecting the cut-off prices, which match the market demand.
2. Ensures Fair Allocation: The cut-off prices reflect the highest demand price, ensuring fair pricing and optimal allotment.
3. Convenience for Retail Investors: It provides a simple, convenient way for retail investors to participate in an IPO without a detailed price analysis.

Conclusion

The cut-off prices are an essential feature in the IPO process, enabling demand-based pricing that benefits both issuers and investors. For retail investors, it offers a simple and effective way to bid for shares without determining a specific price within the band. Understanding the cut-off prices and their role in IPO allotment, mutual fund transactions, and reverse book-building helps investors make informed decisions while participating in capital markets.

As IPOs continue to attract retail and institutional investors, the cut-off prices remain a central element in optimizing accessibility, pricing, and participation in the public issue process.