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Explore the Green Shoe Option in IPO

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Initial public offering (IPO) serves as a critical milestone for companies looking to expand their horizons by going public. One of the key strategies employed during this process is the incorporation of a green shoe option, a financial mechanism designed to ensure price stability after the IPO. 

This blog helps you understand the intricacies of the greenshoe option in IPO, its origins, mechanisms, especially within the Indian market context, guidelines for its exercise, and the regulatory framework governing its application. 

These are all aimed at maintaining market integrity and investor confidence during the often volatile IPO phase.

Green Shoe IPO (Over-Allotment) Option

A greenshoe option in an IPO is a clause in the underwriting contract for an initial public offering that allows the underwriter to sell additional shares beyond the initially agreed amount of shares if there’s more demand than anticipated. It is also known as an over-allotment option. 

This option allows underwriters to issue up to 15% more shares than initially planned if there’s higher-than-expected demand for the stock. This option helps to keep the stock price from rising too quickly and gives underwriters a chance to buy back shares at the original offering price, aiding in price stabilization. 

As an investor, you can take advice from a SEBI-registered advisory while investing funds in such an IPO.

Origin of the Greenshoe Option In IPO

It is called the greenshoe option because Green Shoe Manufacturing, the first company to implement this strategy, introduced it to maintain the stock price’s stability following an initial public offering (IPO). 

Mechanism of Green Shoe IPO Option in India

A greenshoe option in an IPO is a clause that is included in the underwriting agreement of an initial public offering (IPO) allowing the underwriters (the financial experts helping the company go public) to sell more shares than initially planned, up to 15% extra, for up to 30 days post-IPO if the demand is high. 

For instance, if underwriters are to sell 200 million shares, they can issue up to an additional 30 million shares using the green shoe option. This tool serves two primary purposes:

  • Firstly, in successful listed IPOs where share prices rise, underwriters can buy additional stocks from the company at a set price and sell them to their clients at a higher price, making a profit.
  • Secondly, if the share price begins to drop, underwriters can repurchase shares from the market, not the company, to help stabilize the stock price by covering their short position.

Companies may opt out of including a greenshoe option in their underwriting agreements, mainly if they aim to raise a specific amount of money for a project and do not need extra funds.

Guidelines for Exercising Greenshoe Option in India

  1. Timing and Conditions for Exercise

The greenshoe option can be exercised within 30 days following the IPO if market conditions justify its use. The primary condition for its exercise is an oversubscription of the offering or a significant price increase, indicating higher-than-expected demand for the shares.

  1. Determination of Additional Shares

The number of additional shares to be issued under the greenshoe option should be at most 15% of the original number of shares offered in the IPO. The exact amount to be exercised depends on the demand and the desired level of price stabilization.

  1. Pricing of Additional Shares

The additional shares issued under the greenshoe option are sold at the same price as the IPO shares. This ensures consistency and fairness in the pricing for you participating in the IPO.

  1. Stabilization Activities

If the share price starts declining post the IPO, the underwriters may buy back shares to support and stabilize the price. It involves carefully monitoring the market to decide whether to buy back shares and how many to purchase without artificially inflating the stock price.

  1. Disclosure and Transparency

Companies and underwriters must disclose the existence and terms of the greenshoe option in their upcoming IPO prospectus. 

It includes the maximum number of additional shares that may be issued and the conditions under which the option will be exercised. Transparency is crucial to maintain your confidence and market integrity.

  1. Regulatory Compliance

All actions taken under the greenshoe option must comply with the regulations by the Securities and Exchange Commission or the equivalent regulatory body in the country where the IPO is conducted. 

Compliance ensures that the exercise of the greenshoe option is conducted ethically and in accordance with market standards.

Example of Green Shoe Option

Let’s say a company decides to go public, meaning it decides to sell its shares to the public for the first time. This is a big deal because it allows the company to raise a lot of money. 

Now, the company, along with its financial advisors, might consider including a green shoe option in the IPO. This option allows the underwriters (the financial experts helping the company go public) to sell more shares than initially planned up to a specific limit.

For Example:

IPO Details for, say, Company XYZ are:

Offer Price: ₹10 per share

Number of Shares Offered: 100 crore (1 Million) shares

Greenshoe Option: 15% of the offered shares (1,50,000 shares)

The IPO is very successful, and demand for shares exceeds the initial 1 Million shares.

Seeing the high demand, the underwriters decide to exercise the Green Shoe option and sell an additional 150,000 shares at the IPO price of ₹10 per share to stabilize the stock price.

End Result:

  • Without Green Shoe Option: XYZ Corp. raises 10 million (1 million shares x ₹10 per share).
  • With the Green Shoe Option, XYZ Corp. raised ₹11.5 million (1.15 million shares x ₹10 per share).

To Encapsulate

The green shoe IPO option is a strategic tool employed during an initial public offering (IPO) that benefits both the issuing company and investors. By allowing underwriters to sell additional stocks beyond the initial offering, it addresses the issue of excess demand. It mitigates the risk of price spikes that can lead to market instability. 

This option underscores the importance of careful planning and market analysis in the success of a current IPO. It highlights the collaborative effort between the issuing company and its underwriters to achieve a balanced and fair market entry.

Frequently Asked Questions

  1. Who decides whether to exercise the green shoe option?

    The IPO underwriters have the discretion to exercise the green shoe option based on their assessment of market conditions and demand for the stock. Generally, the Greenshoe option is a clause contained in the underwriting agreement of an IPO. It cannot be added or modified after the IPO. 

  2. What is the role of a Stabilizing agent in the green shoe option in IPO?

    The stabilizing agent in the context of a green shoe option plays a critical role in managing and maintaining the stock price's stability immediately following an initial public offering (IPO).

  3. How are additional shares priced under the green shoe option?

    Additional shares issued under the green shoe option are sold at the same price as those offered in the initial IPO, ensuring fairness and consistency for investors.

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I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.

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