Reverse Greenshoe Option

  

Categories: IPO

An IPO is kind of like the moment when a parent takes the training wheels off their kid's bike for the first time. They run alongside the bike for the first few feet, but eventually let go, standing proudly in the street as their kid rides off into the distance.

The reverse greenshoe option is there in case the kid runs directly into a parked car.

In an initial public offering, a company lists its stock on a public exchange for the first time. Typically, there's an offering price, which is the price at which the stock first goes public. Then the shares are off, trading moment to moment, day to day, like any other stock. (That's the "let go of the bike" moment.)

A well-managed IPO will see shares rise early in their trading career. Market demand will be higher than the amount of stock offered. No one wants their stock to go public at $15 and instantly drop to $13. It shows a lack of confidence by the market, and doesn't allow much room to pay off those folks who got in on the deal early, buying shares at the offering price.

Ideally, the stock will see an initial bump...go public at $15 and rise to $17. That situation evidences a much healthier supply/demand dynamic.

A reverse greenshoe option is used to support the share price in case demand for the stock turns out to be lighter than expected. The provision allows the underwriters of the offering (the people running the IPO) to sell shares back to the company. Basically, they can take shares off the market and send them back to the company. The lower supply makes the existing float more valuable (because there are fewer shares to go around), supporting the stock price.

Related or Semi-related Video

Finance: What is a greenshoe option?15 Views

00:00

finance a la shmoop what is a greenshoe option. oh you should be so lucky

00:09

green shoes on leprechauns and investment bankers are such a good thing. [leprechaun smiles]

00:14

why? well because when there is so much excess money laying all over the floor

00:20

your shoes turn green from the bills as you take whatever money you can carry

00:25

and run. that's how the name happened anyway a greenshoe option is a deal term

00:30

that an investment bank negotiates for in an IPO they run. and that IPO remember

00:35

is an initial public offering of stock. this can apply also to secondary

00:40

offerings and other kinds of offerings but we're focused on an IPO here as a

00:43

green shoe lives. if that IPO is marketed so well and there is so much demand for

00:49

shares in the company from the public that the bank believes it can raise the

00:53

IPO price and sell more shares to the public then that IPO was a huge winner.

00:59

the bank will exercise its greenshoe option and instead of selling 30 million [money falls from the sky]

01:04

shares of Chucky LARM calm to the public at 12 bucks a share well it'll bring the

01:09

company public at 15 bucks a share and sell 40 million shares. the math? it

01:15

raises 600 million bucks in the latter green shoe field option versus 360

01:21

million bucks in the former. the green shoe is the extra 10 million shares that

01:27

the bank can sell and get commission on while doing so. and if you think about

01:32

that world as a 5% kind of Commission world well the banks go from 18 million

01:37

in total Commission's to 30 million. yeah nice freakin bump especially when

01:42

there's a basic fixed cost of maybe 10 million dollars in either case. so you

01:47

make a lot more profit on the 30 million story here yeah? all right and having

01:51

more shares out there trading is a good thing for the company because its shares

01:55

are then more liquid. it's easier to buy and sell larger blocks of stock and the [stocks being sold in a graphic]

02:00

big institutions like that. they tend to then take a lot more

02:03

interest in the stock and usually that leads to higher stock prices down the

02:06

line. and all that liquidity or movement shares trading back and forth well

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that's more Commission dollars in the future for the bank. so check your shoes

02:16

if they're green well you're either in the money or you should really get Rover

02:20

to the vet. [green poo on a wood floor]

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