A Greenshoe Option Allows Underwriters to Sell Additional Shares

In many large initial public offerings (IPOs), the bank underwriters decide to exercise their “greenshoe option” to sell additional company shares. This special share arrangement is formally known as the “over-allotment option”. Companies such as Facebook, Alibaba, Exxon Mobil and Saudi Aramco have utilized this option following their respective debuts on public markets.

A greenshoe option is a clause in an underwriting agreement that allows the underwriters to issue additional shares following the IPO. Higher investor demand than anticipated underlies exercising this option. The underwriters purchase the shares at the same price as the base shares in the IPO. Then, they sell the shares to investors. Typically, the greenshoe clause allows the underwriters to sell 15% more shares that the original issue amount. Normally, additional sales must take place within a maximum of 30 days following the IPO.

Variations of the Greenshoe Option

Finally, if the share price falls below the offering price after the IPO, the underwriters are may exercise a reverse greenshoe. In a reverse greenshoe, the underwriters may buy shares in the open market and then sell them back to the company at a higher price.

Greenshoe Option Underwriting
Greenshoe Option Underwriting
Image credit: Carlos Muza

Why Use a Greenshoe Option?

Facebook, Alibaba and Saudi Aramco Examples

In 2014, Alibaba set a record as the biggest IPO in history. This occurred after underwriters exercised their greenshoe option to release additional shares. The underwriters issued an additional 48 million shares on Alibaba’s first day of trading on the New York Stock Exchange (NYSE). Alibaba exercised its overallotment option due to higher than expected investor demand. This made Alibaba’s IPO worth about $25 billion, surpassing the previous $24.3 billion IPO record set by Agricultural Bank of China in 2010.

In its record-breaking $29.4 billion IPO in December 2019, Saudi Aramco exercised its over-allotment option. Aramco initially raised $25.6 billion in its IPO. The underwriters observed an immediate surge in investor demand after going public. Thus, they decided to exert their greenshoe option to issue an additional 450 million shares. The shares, which trade on Saudi Arabia’s stock exchange known as the Tadawul, rose 10% on their first day of trading. The price gave Aramco a valuation of $1.88 trillion, slightly shy of Crown Prince Mohammed bin Salman’s $2 trillion valuation goal.

SEC Supervises with Regulation M

As IPO activity continues to soar in 2021, the greenshoe option has continued to be a popular tool for underwriters. They may use it to promote price stabilization and address heightened investor demand. The greenshoe option has played a role in some of the largest IPOs in recent years and likely will continue to be highly utilized in the capital markets.

Ryan Carpenter serves as Attorney and Managing Director of Carpenter Wellington. Ryan advises clients across a broad set of corporate and commercial matters.

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