The Over-Allotment Option, or Greenshoe (named after the first company to use the instrument), is an often-misunderstood device that gives underwriters the means to stabilize a company’s stock for up to 30 days after an IPO or Follow-On pricing. To help you understand the mechanics and purpose of the Over-Allotment Option, we are going to walk you through a hypothetical deal.
Company Files Prospectus for 10 Million Shares at a Range of $14-16
We will use a 10 million share deal, consisting of only Primary shares being offered by the company, filed at a range of $14-16/share. With the typical over-allotment equal to 15% of the shares covered, the underwriters in this case have an option to purchase a maximum of 1.5 million shares for up to 30 days after the IPO.
At the end of the roadshow, let’s assume the deal prices at $15. A total of 11.5 million shares are allocated to investors. On trade date plus three days (T+3), the underwriters settle the transaction and pay the company for 10 million shares, or $150 million minus the underwriting commissions and discounts. At this point, the underwriters have a short position of 1.5 million shares that they can cover in one of two ways: stock trades above the IPO price in the aftermarket, or stock trades below the IPO price in the aftermarket.
Stock Trades Above the IPO Price in the Aftermarket
If the stock trades above $15, the underwriters will cover the short position by exercising the option to buy the additional 1.5 million shares from the company. By doing this, they are exercising the option to purchase the additional shares and increasing the proceeds of the deal to the company. The underwriters have up to 30 days to make this decision, though in some cases will exercise the option sooner.
In this scenario, it is important to remember that the shares were all sold to the investors at $15 and that the underwriters are not selling the shares at the higher prices in the aftermarket. Thus, the company receives the proceeds based on the $15 price minus underwriting commissions and discounts, even though the stock is higher.
Stock Trades Below the IPO Price in the Aftermarket
If the stock trades at or below $15 within the first 30 days of trading, the Stabilizing Agent (typically the Lead Book-Runner) can use the 1.5 million share short position to become a buyer of stock in the open market. Typically, the Stabilizing Agent may start buying stock at $15 if there are many sellers, and will continue to buy at lower levels until other market participants become buyers and the stock finds a stable price. In this scenario, the 1.5 million share over-allotment position has been covered in the open market so the company will not receive any additional proceeds at the end of 30 days.
Conclusion
The Over-Allotment remains an important mechanism that can bring additional proceeds to a company in an IPO or Follow-On. In the event the stock trades below the deal price, due to market conditions or other factors, it can be a powerful tool to find a stable level for the stock where the company can build a long-term shareholder base.
While much of the deal process and Over-Allotment sounds like arcane banker and trader talk, it’s important to understand. Demystifying this process can put you in a better position to work with your Book-Running Manager(s) and Co-Manager(s).
To learn more about Gilmartin and how we strategically partner with our clients, contact our team today.
Tom Brennan, CFO
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