Considering the hype all around about Initial Public Offering (IPO), you might be aware of the basics of it. If you are a keen investor, you would also be wary of companies going public soon.
If you are a new investor, then there will be many aspects of IPO that you might not be aware of. The cut-off price is one such factor. This post entails everything about the cut-off price in an IPO and its importance.
Defining Cut-Off Price in IPO
A cut-off price in an IPO is referred to the price at which a company issues its shares to investors. After evaluating the investors' requirements for the shares and the book, the company makes a decision. It is the real identified issue price, which could be any in the given price band. As per the SEBI’s guidelines, only individual retail investors can apply for an IPO at the cut-off price.
Let’s understand it further with an example. Suppose ABC Corporation has launched its IPO with a price range between Rs. 100 – Rs. 110. You can apply for five shares at a price of Rs. 105. Since you wish to subscribe at up to Rs. 105, you will get the share price as Rs. 102 if it is the decided issue price.
But, in case the decided price of the issue is Rs. 106, you will not get the share allotment. If you go with the cut-off, you will become eligible for the share allotment at any price of the issue.
Types of IPO Pricing in India
In India, there are two different types of IPO pricing mechanisms, as mentioned below:
Fixed Price Mechanism
Under this mechanism, the price of an IPO is set by the company in advance. This price makes the IPO open to the public. The fixed price mechanism reveals information about investors from varying categories on the issuance day. Underneath this methodology, there is no method to determine the demand for shares before the date of issuance. Thus, whenever a company chooses to go with the fixed price method, the Securities and Exchange Board of India (SEBI) has mandated to allot 50% of the entire share lot to retail investors.
Book Building Method
The price of IPO is not comprehended at the beginning of the book-building method. The corporation declares price ranges whenever it launches the IPO. And then, investors start bidding through a price range between such pricing bands. It becomes the responsibility of the issuer to identify this floor price or the price band in the red herring prospectus if the book-building method is followed.
The Role of Cut-Off Price in IPO
When an IPO is nearing closure, investment bankers start with the price discovery process. But, since there is no establishment of the set price, there will be several bids occurring at varying values.
The bankers have the final say on the price by evaluating the weighted average of the received offers. The cut-off price becomes the ultimate established price. In case there is a popular issue generating more bids than the number of shares available on the offer, the cut-off price in the IPO turns out to be the ceiling price.
Once the cut-off price is set, investors who had placed bids below this range will get reimbursed the entire amount as they will not get the IPO allotment. On the contrary, investors who had bid above the cut-off price and have been allotted the shares will get the excess amount reimbursed.
If there comes a situation when an investor would want the IPO allotment, regardless of the consequences, they will have to select the option to purchase shares at cut-off by filling out an application. This will make sure that the investor is eligible for this allocation, irrespective of the cut-off price.
How to improve the chances of getting an IPO allotment?
If an IPO becomes oversubscribed, the chances of getting the allotment become extremely low if you have a bid lower than the top of the price range. Even if you choose the higher price range, the chances of receiving the allotment are slim still, especially if the offering is popular.
With the IPO market going rampant, getting allotments is somewhat the same as getting a lucky draw. And choosing the cut-off in an IPO is one of the best ways to get the odds in your favor. Additionally, there are some other ways you can use to enhance the allotment chances, such as:
- Bidding only for one lot
- Using the Demat accounts of a family member or a friend to apply
- Applying on the IPO’s first day
However, there is no guarantee that you will get the allotment when you apply for oversubscribed IPOs.
Frequently Asked Questions (FAQS)
Can I bid more than the cut-off price in the IPO?
Yes, you can bid at a higher price than the cut-off price. The allotment in Offer for Sale (OFS) gets decided on the highest priority price.
Should we bid at the cut-off price?
If you want to bid at the cut-off price, you can easily do so. Through this, you improve your chances of getting the share allotment significantly. Also, keep in mind that you will not get a refund and allotment if you are not an option for the cut-off price and bidding below the final price. If you bid more than the final price, you will get a refund of this difference.
How is the cut-off price calculated?
A weighted average of all the received bids in total is evaluated to decide the final price by the bankers. This final price that is zeroed upon is referred to as the cut-off price. If an IPO issue is extremely popular and attracts excess bids than the shares available on the offer, this price is generally the ceiling price.
Is IPO first come, first serve?
No, the allotment of IPO does not work as per the first come, first served methodology. The process of allotment entirely depends upon the response that the IPO is getting from investors. If there is a situation where the IPO is undersubscribed than expected, the investor can get all the lots allotted for which they applied. On the contrary, getting the allotment becomes tougher if an IPO is oversubscribed.
How many bids should I make for an IPO?
All in all, you can make a maximum of three bids at once. To do so, you will have to put in your Demat account number and bid the number of stocks that you want to buy. Also, fill up additional necessary details and submit this application. Once done, you will get information and details containing the application number and other transactional particulars.
What is the lower and upper size in an IPO?
The price range the underwriter and the issuer agree upon is known as the price band. Now, the bottom band is known as the lower limit, and the upper limit is referred to as the top band.
Why is the IPO price more than face value?
Typically, the price of the issue is higher as compared to the face value. This gap between the IPO price and the face value is based upon a variety of factors, like the growth prospects of the company, the interest of investors, and more. It also fluctuates according to the demand and supply.