Ahead of an initial public offering (IPO) process, companies work with their advisors to value their company.They use that information to determine how many shares they can sell and at what price.
This helps them determine a maximum price at which they can sell all of their shares, and that’s the price at which they set their IPO.
The Price Band and Cut-Off Price
An IPO cut-off price is the price at which a company issues shares to investors. This is often a band with a minimum and maximum acceptable price. Investors who bid on a company’s stock at or above the cut-off price will receive shares, so part of their investing strategy will be to determine the right amount to bid.
Essentially, a price band is a range of prices for the issuance of IPO shares — there’s a minimum and a maximum. Investors can place bids on a number of shares at a given price within that range. It’s much like an auction, in that respect.
When companies decide to go public, they might price their shares in advance of an IPO through a fixed-price mechanism. But there’s another method, the book-building method, where the underwriter determines the IPO price by collecting bids within a price band.
Now, when investors bid within the price band, the bids help a company come to a determination of how much its shares should be worth. Depending on how many shares the company is issuing and the number of bids (and the prices of those bids), the company ultimately finds the highest price at which it can issue shares.
That price is the cut-off price and the price at which shares will publicly IPO.
Calculating Cut-Off Price
Calculating an IPO cut-off price depends on a few variables
• The range of the price band
• The number of shares being issued
• The number of bids and their corresponding prices
With all of those variables taken into account, underwriters use a weighted average to find the highest possible price at which the company can issue all of its shares. That price is the cut-off price.
Cut-Off Price Example
For example, say a company determines it wants to issue 100 shares and sets a price band between $5 and $10. Investors can bid for a number of shares at any price in that range. There may be one investor who wants five shares at $6, another that wants 25 shares at $9, etc. Once all the respective shares have received bids, the company crunches the numbers and determines the cut-off price found.
Again, that price would be the highest price at which the company could issue its shares. If enough investors submitted high enough bids for enough shares, the cut-off price would be closer to the high-end of the price band, perhaps $8, which would then be the cut-off price for the IPO.
IPO Pricing Explained
There are different types, models, and mechanisms used by companies to issue shares at certain prices, and despite there being so much money at stake, pricing IPOs is far from an exact science.
Generally speaking, before a company’s shares start trading on the market (where supply and demand dictate their value), the company decides how many shares to issue. And the considerations of three primary constituencies — company employees who want to sell shares, underwriters, and investors — will sway the ultimate pricing of an IPO.
IPO Pricing: Fixed-Price vs Book Building
There are a couple of ways that companies calculate their IPO prices:
In this method, the company going public determines a fixed price for its shares, and then offers them to investors at that price. Investors know how much they’re paying for shares, which is a key difference from the book building method.
Book Building Method
Pricing under the book-building method involves the elements we’ve discussed throughout this piece: Price bands, bids, and IPO cut-off prices. After investors bid on shares within the specified pricing range, the company determines the cut-off price. Investors may or may not get their allotment once the company goes public (remember, if you bid below the cut-off price, you’re likely to be left out).
The book building method for IPOs has become the norm for most IPOs, and research has shown that it tends to generate the most capital, too.
IPO Share Allotment
The method of allocating shares depends, usually on the brokerage to buy the IPO.
That’s because certain brokerage accounts have different rules and criteria that dictate which customers can participate in IPO investing, and also, for which customers receive an allocation of shares through the IPO process. Generally, the more money or assets you have, the longer your relationship with your brokerage, the higher priority you’ll receive in the queue.
There are also requirements set forth by the Financial Industry Regulatory Authority (FINRA) (which your brokerage will usually guide you through).
Even if you follow the right processes, it may still be hard to get in on the action. In fact, only around 10% of the issued shares will end up going to retail investors — most go to institutional investors. So, for most investors, getting in on an IPO before shares hit the stock exchanges may prove very difficult.
Investing in IPOs can be exciting, but it can also be a risky endeavor. IPOs can be volatile investments. That’s why it’s important to research potential investments, including knowing the IPO cut-off price is and considering how much you think a potential IPO might be worth.
One way to get started investing in IPOs is by opening a brokerage account on the SoFi Invest® stock trading app. In addition to getting in on IPOs, the account will also let you invest in stock, exchange-traded funds, and cryptocurrency from your phone.
Here are a few fast answers to your lingering IPO cut-off price questions:
What is the cut-off time for an IPO?
Cut-off time for an IPO is the last day and time that a retail investor can bid on IPO shares. After that, investors need to wait until shares hit the stock exchange.
How is the IPO cut-off price determined?
Several factors go into the determination of a cut-off price. Those include the total number of shares a company is issuing, the price band, and the number of bids, and the price-points of those bids within the price band.
Should I bid at the cut-off price?
That’s something only you (and a financial professional familiar with your goals) can answer. But if you do want to invest in the next hot IPO stock, bidding at the cut-off price should may help you get an allotment of shares.
Photo credit: iStock/bankrx
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.
New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.