Over-allotment option: Overview, definition, and example
What is an over-allotment option?
An over-allotment option, also known as a greenshoe option, is a provision in securities offerings that allows underwriters to sell more shares than initially planned, usually up to 15% more than the original offering size. This option helps stabilize the stock price after an initial public offering (IPO) by providing additional shares to meet excess demand.
For example, if a company offers 10 million shares in an IPO, the underwriters may have an over-allotment option to sell an additional 1.5 million shares if demand exceeds expectations.
Why is an over-allotment option important?
An over-allotment option is important because it helps manage price volatility in the early days of trading. If demand is high, underwriters can sell additional shares to prevent excessive price spikes. Conversely, if the stock price starts to drop, underwriters can buy back the extra shares to provide support, stabilizing the market.
For companies, this option ensures they can raise additional capital if investor demand is strong. For investors, it helps prevent extreme price fluctuations, making the offering more predictable.
Understanding over-allotment option through an example
Imagine a tech company launches an IPO with an offering of 20 million shares at $20 per share. Due to strong investor demand, underwriters exercise their 15% over-allotment option, selling an additional 3 million shares at the same price. This allows the company to raise more capital while ensuring a stable market entry.
In another case, if an IPO stock initially struggles and drops below the offering price, underwriters may buy back shares from the market, using the over-allotment option to support the price and reduce volatility.
An example of an over-allotment option clause
Here’s how an over-allotment option clause might appear in a securities offering agreement:
“Underwriters shall have the option to purchase up to an additional [X]% of the shares offered pursuant to this Agreement, exercisable within [X] days of the initial offering date, to cover over-allotments and stabilize the market price.”
Conclusion
An over-allotment option allows underwriters to sell extra shares beyond the original offering size, helping to stabilize stock prices and meet investor demand. By providing flexibility in securities offerings, this mechanism benefits both companies raising capital and investors seeking a balanced market.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.