Greenshoe options are commonplace in IPOs in the U.S. today, and, as you’ll learn, you can easily find examples of them being used. Keep reading to learn more about greenshoe options and how they work.
Definition and Example of a Greenshoe Option in an IPO
A greenshoe option is a provision in an underwriting agreement that gives underwriters the right to sell more shares than initially agreed on. Greenshoe options, also known as “over-allotment options,” are included in nearly every initial public offering (IPO) in the United States.
Alternate name: over-allotment option
A recent example of a greenshoe option being used in an IPO occurred in July 2021 when Robinhood went public. During the popular trading platform’s IPO, it granted an over-allotment option to its underwriters, which included Goldman Sachs, J.P Morgan, Barclays, Citigroup, and Wells Fargo Securities. This option allowed them to collectively buy an additional 5,500,000 shares of its Class A common stock at the IPO price, minus any underwriting discounts and commissions. The company went public at the end of July; at the end of August, Robinhood announced that its underwriters had partially exercised the greenshoe option, purchasing 4,354,194 shares of Class A common stock. This option alone increased Robinhood’s IPO proceeds by an additional $158.5 million.
How a Greenshoe Option in an IPO Works
As a company prepares to go public, it works with its underwriters to determine the number of shares to offer and the price at which to offer them. But in some cases, the demand for IPO shares may exceed the actual number of shares available. That’s where the greenshoe option comes in. Let’s say, for example, that a popular technology company was planning to go public on March 31, 2022. After consulting with its underwriters, the company agreed to offer 100,000 shares at $25 per share, with total expected proceeds to be $2.5 million. Say the underwriting agreement includes a greenshoe option, which allows the underwriters to sell an additional 15,000 shares—or 15% of the number of shares offered—if demand is high. However, they must exercise the option by April 30. If the underwriters fully exercised the greenshoe option, it could increase the company’s IPO proceeds by an additional $375,000: 15,000 shares x $25 = $375,000 Underwriters could choose to either fully or partially exercise the option. In this example, where the company had an over-allotment option for 15,000 additional shares, if the underwriters sold all 15,000 additional shares, then they could do a full exercise of the option. But if only an additional 10,000 shares were sold, then it would constitute a partial exercise.
What It Means for Individual Investors
You might be wondering how a greenshoe option affects you as an investor. On one hand, it affects investors by increasing the number of shares available to purchase. This increased liquidity in the market could result in more investors being able to purchase the IPO stock. On the other hand, only certain investors typically have access to the IPO market, and a greenshoe option doesn’t necessarily change that. A greenshoe market could potentially affect individual investors after the IPO, when initial investors resell their shares in the public market. If a greenshoe option was exercised, then more shares entered the market than was originally planned. As a result, there are more shares outstanding that could potentially be available to you as an investor.
