What Is a Greenshoe Option in an IPO?

Greenshoe Option in an IPO Explained in Less Than 5 Minutes

Definition
A greenshoe option, also known as an “over-allotment option,” gives underwriters the right to sell more shares than originally agreed on during a company’s IPO.
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A greenshoe option, also known as an “over-allotment option,” gives underwriters the right to sell more shares than originally agreed on during a company’s IPO. These provisions can help underwriters meet higher-than-expected demand up to a certain percentage above the original share number.

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.

Note

The name “greenshoe option” comes from the IPO of the Green Shoe Manufacturing Company. When the company went public in 1963, it was the first to allow for an over-allotment option, now informally known as the greenshoe option.

  • 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.

Note

Using the greenshoe option, the underwriters can sell more shares than were initially offered through the IPO. This over-allotment provision typically allows the underwriters to sell up to 15% more shares at the agreed-upon IPO price and can be exercised up to 30 days after the IPO.

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.

Note

In most cases, those who have the opportunity to invest in IPO shares are clients of the underwriters. Those clients are generally high-net-worth individuals, mutual funds, insurance companies, hedge funds, and other similar institutional investors. Regardless of whether there’s a greenshoe option that increases the number of shares, they aren’t available to most individual investors.

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.

Key Takeaways

  • A greenshoe option, also known as an over-allotment option, is a provision in an underwriting agreement that allows underwriters to sell more shares of a company’s stock.
  • Greenshoe options are used during most U.S. initial public offerings (IPO) to help meet high investor demand, as well as increase the company’s IPO proceeds.
  • Underwriters exercise either a partial or full exercise of a greenshoe IPO depending on how many shares of stock the underwriters sell.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Harvard Law School. "Underwriters Do Not Use Greenshoe Options To Profit From IPO Stock Pops." Accessed Feb. 8, 2022.

  2. Ross Geddes. “IPOs and Equity Offerings.” Elsevier Science, 2003. Accessed Feb. 8, 2022.

  3. Robinhood. “Robinhood Markets, Inc. Announces Partial Exercise of IPO Underwriters' Over-Allotment Option To Purchase Additional Shares.” Accessed Feb. 8, 2022.

  4. Morrison & Foerster. “Frequently Asked Questions about Initial Public Offerings.” Accessed Feb. 8, 2022.

  5. U.S. Securities and Exchange Commission. “Investor Bulletin: Investing in an IPO.” Accessed Feb. 8, 2022.

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