What it means
When a company goes public, banks buy the shares from the company and sell them on to investors. The greenshoe is written into the underwriting agreement and gives the banks the right, usually for 30 days after the offering, to buy extra shares from the company at the offer price.
The usual limit is 15% of the base offering. The name comes from the Green Shoe Manufacturing Company, which in 1963 was the first to use this feature in a share offering.
It is now standard in IPOs (initial public offerings) and many other large share sales around the world. At the pricing, the banks sell more shares than the base offering, up to 15% extra, so they hold a short position, meaning they owe shares they do not yet have.
If the share price rises after listing, they exercise the option and buy the extra shares from the company at the offer price to cover. If the share price falls, they buy the shares back in the market, which props up the price, and the option is left unused.
The mechanism benefits everyone in a modest way. The company can raise more money if the offering is popular, investors get some price stability, and the banks are protected against losses from supporting the market.
It does not eliminate risk, and prices can still fall below the offer price if there is heavy selling. Finance professionals watch the greenshoe because it affects the final proceeds and the number of shares outstanding.
It also tells you something about the deal: if the option is exercised in full, it signals that demand was strong. If it expires unused, the price probably fell below the offer.
In practice
Real-world examples.
Example
A software company lists its shares at $25, and demand is three times the shares on offer. The share price jumps on the first day, and the banks exercise the greenshoe in full, raising the company's proceeds by 15%.
Example
A bank sells shares to fund an expansion and sees the share price slip below the offer price on day two. The underwriters buy shares in the market, which supports the price and uses up the short position they created through the over-allotment.
Example
A fund manager reviews the prospectus for a new listing and notes that it includes a 15% greenshoe. She calculates the maximum number of shares that could be issued, so she can estimate the possible dilution of her holding.
Formula
Calculation
Greenshoe shares = Base offering shares x 15%
Extra proceeds = Greenshoe shares x Offer price
Suppose a company plans an IPO of 10,000,000 shares at $20 each, raising 10,000,000 x 20 = $200,000,000. The greenshoe covers 10,000,000 x 0.15 = 1,500,000 additional shares. If the price rises and the banks exercise it in full, the company raises a further 1,500,000 x 20 = $30,000,000, for a total of 11,500,000 shares and $230,000,000 before fees. If the price falls to $18 instead, the banks buy back 1,500,000 shares in the market at $18, supporting the price, and the company raises only the original $200,000,000.Case study
Seen in the real world.
Brightwave Energy is an illustrative, fictional renewable power developer that went public by offering 20,000,000 shares at $12, raising $240,000,000. The underwriting agreement included a greenshoe of 3,000,000 shares, which is 15% of the base deal.
In the first week the shares traded between $11.60 and $12.40, and the banks bought back some of the over-allotted shares at prices below $12 to support the price. They exercised the option only for the remaining shortfall of 1,200,000 shares, which raised an extra 1,200,000 x 12 = $14,400,000 for the company.
The chief financial officer recorded the extra proceeds, noted the increase in the share count and updated the earnings per share forecast. The illustrative lesson is that the greenshoe gave the company a small bonus without hurting the share price. The company's treasury team also noted that it had to reflect the extra 1,200,000 shares in its share count and reserves before reporting its first quarterly results.
Watch out
Common mistakes.
- Assuming the greenshoe is always exercised in full, when it depends on how the share price behaves after listing.
- Forgetting the extra shares when calculating ownership and dilution, which can overstate how much of the company you will keep.
- Thinking the greenshoe guarantees a rising price, when it only helps limit declines.
Questions
People also ask.
Why is it called a greenshoe?
It is named after the Green Shoe Manufacturing Company, the first company to use the feature in a share offering.
How much can a greenshoe be?
The usual maximum is 15% of the base offering, which is what many stock exchanges and regulations allow.
How long does the underwriter have to use it?
Typically about 30 days from the start of trading.
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