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What is The Cut-Off Price in an IPO?

By Samuel Becker · January 28, 2022 · 4 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

What is The Cut-Off Price in an IPO?

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:

Fixed-Price Mechanism

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.

Recommended: Institutional vs. Retail Investors: What’s the Difference?

The Takeaway

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.

FAQ

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


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