When a company uses the IPO route to raise capital and issue its securities, it has to issue an offer document that contains all the details of the IPO and the company itself. One important term that forms part of the offer document is the ‘Green Shoe Option’.
The green shoe option is used by an issuing company to safeguard itself in case of lower demand for its shares in the market. It is also used in case the share price falls below the offer price post issue. As part of this option, the issue underwriters intervene in such cases and purchase some number of the company’s shares at a fixed price. This helps them maintain the share prices and create a demand for the shares.
In case the market price of the company’s stocks is lower, the underwriters in an IPO do not exercise the green shoe option. Instead, they purchase the shares at the market price.
If the market price is higher, they use the green shoe option and purchase it at the offer price.
The green shoe option is basically the benefit or privilege that allows the underwriters to purchase the shares at the offer price. Underwriters are issued an additional 15% shares of the total issue size under the green shoe option. Furthermore, underwriters can exercise the green shoe option only within 30 days of the date of the IPO
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