Cut-off price in IPO: Meaning and significance for investors

Initial Public Offerings (IPOs) present an opportunity for investors to purchase shares of a company before they start trading on an exchange. But before participating in an IPO, it is important for investors to understand key terms and concepts about the bidding and allotment process.

One such important concept is that of the IPO cut-off price. In this article, we'll explain what cut-off price means, its significance in an IPO, and how it relates to your investment decision.

• Table of contents

• What is cut-off price in IPO?
• Two types of IPO pricing
• How is the cut-off price determined?
• Formula for calculating cut-off price
• Factors affecting cut-off prices in IPOs
• Importance of cut-off price in IPO
• How to bid at the cut-off price
• Improving chances of getting allotment

What is cut-off price in IPO?

The cut-off price is the final price at which shares are allotted in a book-building IPO. When an IPO is launched under the book-building method, a price band is set by the company and its underwriters. Investors can then bid within this price range. The cut-off price is the price at which shares are eventually allotted to eligible bidders after considering demand.

Two types of IPO pricing

To better understand the concept of cut-off price in an IPO, it is important to learn how IPOs are priced. Typically, there are two pricing mechanisms:

1. Fixed price IPO: In this type of IPO, the company sets a single price at which the shares will be offered. Investors who apply for the IPO are required to pay this fixed price. Cut-off pricing is not applicable to fixed price IPOs.
2. Book building IPO: Here, a price band is set (for example, Rs. 100–Rs. 110), and investors can bid within that range. After the bidding process is complete, the company, along with its underwriters, decides on the final cut-off price based on the bids received.

Also Read: What is Primary market?

How is the cut-off price determined?

After the bidding period closes, the company and its underwriters review all the bids and determine the number of bids at each price point within the price band. Based on overall demand and the number of shares available, they choose a price at which the maximum number of shares can be allotted. This is called the cut-off price.

However, even once the cut-off is decided, not all eligible bids may get shares, especially if the IPO is oversubscribed. In such cases, allotment is done through a lottery for retail investors.

Formula for calculating cut-off price

There is no fixed formula to calculate the cut-off price. It is discovered based on investor demand across price levels. The issuer and underwriters review:

• Total shares offered
• Bids received at each price point
• Aggregate demand relative to supply

The cut-off price is the level where demand matches or exceeds the number of shares available.

Factors affecting cut-off prices in IPOs

Several factors influence the final cut-off price in a book-building IPO:

• Demand for the IPO: Higher demand may lead to a higher cut-off price.
• Company valuation: The company’s growth potential, financial strength, and fundamentals can impact how the market values the offering.
• Market conditions: Prevailing sentiment and market trends can influence investor enthusiasm, indirectly affecting the final price.
• Investor expectations: Strong institutional or retail interest, based on perceived future prospects, can push bids toward the upper end of the band.

Importance of cut-off price in IPO

The cut-off price helps encourage transparency and standardisation. It ensures that all retail investors who receive an allotment pay the same final price for the shares.

For retail investors, bidding at the cut-off price helps ensure their application is considered valid regardless of the final issue price. However, this does not guarantee allotment, particularly in cases of oversubscription, because if demand exceeds supply, a lottery is held to decide the final allotment.

The cut-off price helps preserve the integrity of the book-building process by standardising share allocation. This mechanism is especially important in IPOs where mutual funds, retail, and institutional investors participate simultaneously, often at different bid levels.

How to bid at the cut-off price

When you apply for a book-built IPO, you can choose to bid at the “cut-off price” instead of quoting a specific price. This option is available only to retail individual investors.

By selecting this option, you do not enter a specific price—you’re simply authorising your bid to be considered at whatever price the issuer finalises once all bids are received. This removes the need to predict the correct bid price within the band.

Improving chances of getting allotment

While there's no guaranteed way to secure IPO shares, here are a few steps that may help improve your chances:

• Bid at the cut-off price: This keeps your application valid regardless of where the final issue price settles within the price band.
• Apply early during the bidding window: Submitting your application early in the IPO period helps avoid last-minute technical issues or bank delays, though it doesn’t impact allotment priority.
• Ensure sufficient funds and mandate approval: Make sure there's enough balance in your bank account and that mandate is approved in time. Incomplete or delayed mandates may lead to rejection.

Also Read: What is the difference between NFO and IPO?

Conclusion

Understanding the concept of the cut-off price is essential for investors participating in book-built IPOs. Retail investors can use the cut-off option to simplify their bidding process, but should remain aware that this does not ensure allotment.

If you're interested in gaining exposure to companies going public but find the IPO process too time-intensive or complex, you could also consider mutual funds. Some mutual funds participate in IPOs as part of their broader equity strategy. In such cases, the fund manager handles the evaluation and application process for the portfolio.

Whether investing directly or through mutual funds, being familiar with how IPO pricing works can lead to more informed decisions.

FAQs

What price do I bid in an IPO?

You can bid any amount within the price band or select the “cut-off price” option (only in book-built IPOs) if you prefer not to specify a price.

What is the cut-off price for an IPO subscription?

The cut-off price is the final price at which shares are allotted to investors in a book-building IPO.

How to calculate the cut-off price?

It is determined after evaluating all bids and identifying the price point at which demand matches or exceeds supply. There is no fixed formula.

How is the IPO price decided?

The issuer and its underwriters evaluate demand and market conditions to finalise the issue price or cut-off price.

Who can apply at the cut-off price in an IPO?

Only retail individual investors are allowed to select the “cut-off price” option when applying for a book-built IPO.