What is an overallotment (greenshoe)?
An overallotment option—commonly called a greenshoe—is a provision in an underwriting agreement that permits the underwriters of an initial public offering (IPO) or a follow‑on (secondary) offering to sell up to an additional 15% of the number of shares originally planned. The option typically can be exercised for a set period after the offering (commonly up to 30 days). It gives underwriters flexibility to meet excess demand or to stabilize the share price shortly after the offering.
Why it exists (two main purposes)
– Raise additional capital: If demand is higher than expected and the stock trades above the offering price, exercising the option allows the issuer to sell more shares at the offering price and raise extra proceeds.
– Price stabilization: If the stock falls below the offering price, underwriters can intervene in the open market—buying back shares to support the price—or if the stock rises, they can exercise the option to buy the extra shares from the issuer at the offering price to cover short positions. Both uses help reduce post‑offering volatility.
How the mechanics work (step‑by‑step)
1. Inclusion in underwriting agreement and prospectus
– The issuer and lead underwriter agree on an overallotment clause (up to 15%) and disclose it in the prospectus/registration statement so investors know the potential share count.
2. Initial sale and short positions
– Underwriters sell the advertised offering size to investors. To sell more than the initial allotment (i.e., up to the 15%), they may overallot the issue by selling more shares than are available—effectively creating a short position equal to the extra shares sold.
3. Post‑offer price observation (stabilization period)
– During the stabilization window (commonly 30 days), underwriters monitor the market price relative to the offering price.
4. Two possible outcomes
– If the stock trades above the offering price: underwriters exercise the overallotment option, buying the extra shares from the issuer at the offering price to cover their short position. This raises additional capital for the issuer.
– If the stock trades below the offering price: underwriters buy shares in the open market to cover their short position and stabilize the price. They do not exercise the option in this case; instead they absorb the market risk and reduce float to prop up the price.
5. Closing the option
– The underwriters either exercise the option (if favorable) or let it lapse after the agreed period, having covered their short positions via market purchases if necessary.
Numeric example
– Issuer plans to sell 10,000,000 shares at $20.00.
– Overallotment size (15%) = 10,000,000 × 0.15 = 1,500,000 shares.
– Total potentially sold at launch = 11,500,000 shares.
– If market demand drives the price to $25 within the option period, underwriters can exercise the greenshoe, buy 1,500,000 shares from the issuer at $20 to cover the short, and the issuer receives an additional $30,000,000.
– If instead price falls to $18, underwriters will likely buy shares at market to cover the short and support the price rather than exercise the option.
Real‑world example
– Snap Inc. IPO (March 2017): Snap initially offered 200 million shares at $17. Underwriters exercised the overallotment to sell an additional 30 million shares (15% of 200 million), bringing total shares sold to 230 million. (S&P Global reported the underwriters exercised their option.)
Practical steps and checklists
For issuing companies (management, CFO, legal):
– Decide whether to include an overallotment option and its size (up to 15% is typical in many markets).
– Disclose the option clearly in the prospectus/registration statement with the conditions and time window.
– Coordinate with underwriters on how proceeds and dilution will be handled if exercised.
– Consider investor relations messaging about potential dilution and stabilization activities.
For underwriters / lead managers:
– Negotiate the overallotment clause with the issuer and include it in the underwriting agreement.
– During bookbuilding, decide how aggressively to overallot; use shorting/hedging strategies as needed.
– Monitor secondary trading closely in the stabilization period.
– Choose whether to exercise the option (if price > offer) or buy back shares in the market to stabilize and cover shorts (if price < offer).
– Ensure compliance with securities laws and exchange rules governing stabilization and market manipulation.
For investors (retail and institutional):
– Read the prospectus to see if a greenshoe is included and the size/timeframe.
– Recognize that post‑IPO price movements in the first month may be affected by underwriters’ stabilization activity.
– Understand that exercising a greenshoe that raises new shares will dilute existing holders relative to the initial promised share count.
– Use the existence and likely use of a greenshoe as one of many inputs when evaluating IPO liquidity and short‑term price behavior.
Regulatory and compliance considerations
– Greenshoe and stabilizing activities are subject to securities laws and exchange rules in each jurisdiction. Market stabilization is permitted under controlled conditions but is prohibited if it constitutes manipulation.
– Underwriters must follow disclosure rules and often register the option in offering documents.
– Exact allowable practices and reporting obligations vary by country; consult securities counsel or local regulators for specifics.
Advantages and disadvantages
Advantages
– Helps issuers raise additional capital if demand is strong.
– Gives underwriters a tool to reduce extreme short‑term price volatility and help maintain orderly markets after an offering.
– Can increase investor confidence by reducing the chance of a chaotic immediate post‑IPO market.
Disadvantages and risks
– If exercised, it increases the total shares outstanding (dilution).
– Stabilization (buying in the market) can be costly to underwriters and may not succeed if selling pressure persists.
– If perceived as manipulation, it can attract regulatory scrutiny—so underwriters must operate within rules and disclose activities.
Quick FAQs
– How large can an overallotment be? Typically up to 15% of the original shares offered—this is common practice in many markets but check the local norm and the prospectus.
– How long can underwriters exercise it? Commonly up to 30 days after the offering, but the exact period is set in the underwriting agreement.
– Does exercising the option always benefit the issuer? Only if demand and pricing justify selling more shares at the offering price; it can be beneficial (extra capital) or unnecessary (if the underwriters instead stabilize via market purchases).
Sources and further reading
– Investopedia, “Overallotment,” accessed via: https://www.investopedia.com/terms/o/overallotment.asp
– S&P Global, “Underwriters exercise option in Snap IPO,” March 2017 (reporting that underwriters exercised the overallotment to sell an extra 30 million shares in Snap’s IPO).
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.