A Quick Take on Green-shoe Option in IPO?

When the State Bank of India (SBI) recently announced that it’s planning to raise Rs 10,000 crore via a public issue or private placement in the current financial year, it also mentioned that the fundraising includes a Green-shoe Option (GSO) of Rs 5,000 crore.

So, what exactly is a Green-shoe Option? But first, it is important to understand the role of an underwriter. When a company intends to launch an initial public offering (IPO), it hires the services of an underwriter–which is an entity, bank, or group of banks or brokerage agencies. Underwriters play an important role in this case. As they work on a percentage basis, underwriters expect IPOs to raise as much capital as possible.

The Green-shoe Option, also referred to as the overallotment option, allows the underwriters to sell more shares than the initially agreed number within 30 days of issuing the IPO.

So, if the stock price rises, underwriters buy extra stock from the company—up to 15%— and sell it to the public at a profit. Usually, underwriters buy the stock at a pre-determined price.

In case the price dips, these underwriters buy back shares from the public. This option helps stabilise the pricing of the share without incurring any loss to the investors.

Suppose the IPO paperwork specifies that the company has a Green-shoe Option agreement with its underwriter, in that case, it tends to boost confidence among investors assuring that the company’s share is unlikely to fall far below the offer price. Green-shoe Option, therefore, is one of the features that purchasers seek in an offer contract.

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