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.
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Finance: What is a greenshoe option?15 Views
finance a la shmoop what is a greenshoe option. oh you should be so lucky
green shoes on leprechauns and investment bankers are such a good thing. [leprechaun smiles]
why? well because when there is so much excess money laying all over the floor
your shoes turn green from the bills as you take whatever money you can carry
and run. that's how the name happened anyway a greenshoe option is a deal term
that an investment bank negotiates for in an IPO they run. and that IPO remember
is an initial public offering of stock. this can apply also to secondary
offerings and other kinds of offerings but we're focused on an IPO here as a
green shoe lives. if that IPO is marketed so well and there is so much demand for
shares in the company from the public that the bank believes it can raise the
IPO price and sell more shares to the public then that IPO was a huge winner.
the bank will exercise its greenshoe option and instead of selling 30 million [money falls from the sky]
shares of Chucky LARM calm to the public at 12 bucks a share well it'll bring the
company public at 15 bucks a share and sell 40 million shares. the math? it
raises 600 million bucks in the latter green shoe field option versus 360
million bucks in the former. the green shoe is the extra 10 million shares that
the bank can sell and get commission on while doing so. and if you think about
that world as a 5% kind of Commission world well the banks go from 18 million
in total Commission's to 30 million. yeah nice freakin bump especially when
there's a basic fixed cost of maybe 10 million dollars in either case. so you
make a lot more profit on the 30 million story here yeah? all right and having
more shares out there trading is a good thing for the company because its shares
are then more liquid. it's easier to buy and sell larger blocks of stock and the [stocks being sold in a graphic]
big institutions like that. they tend to then take a lot more
interest in the stock and usually that leads to higher stock prices down the
line. and all that liquidity or movement shares trading back and forth well
that's more Commission dollars in the future for the bank. so check your shoes
if they're green well you're either in the money or you should really get Rover
to the vet. [green poo on a wood floor]
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