Primary Market: Issued Shares
The primary source of IPO shares is the issuing company itself. Before going public, the company determines the number of shares it intends to offer and the price at which they will be sold.
These shares are newly issued, meaning they are created specifically for the IPO and are not traded in any secondary market prior to the offering.
When a company goes public, it engages underwriters, typically investment banks, who facilitate the IPO process.
Underwriters help determine the optimal offering price, market the shares to potential investors, and handle the administrative tasks involved.
The underwriters purchase the IPO shares from the issuing company at a discounted price and then sell them to institutional investors, retail investors, and other interested parties in the primary market.
The number of IPO shares allocated to individual investors may vary. Institutional investors, such as mutual funds or pension funds, often receive larger allocations due to their significant investments.
Retail investors, on the other hand, generally receive smaller allocations and may have to purchase shares through their brokerage accounts.
Secondary Market: Existing Shareholders
While most IPO shares come directly from the issuing company, some may come from existing shareholders. These shareholders, including founders, early investors, and employees, may choose to sell a portion of their holdings during the IPO. This provides an opportunity for them to monetize their investments and realize capital gains.
The decision to sell existing shares during an IPO is often subject to lock-up agreements. Lock-up agreements restrict the sale of shares for a specified period following the IPO.
This is done to promote stability in the stock price and prevent excessive volatility resulting from a sudden influx of shares into the market. Once the lock-up period expires, existing shareholders may choose to sell their shares in the secondary market.
It’s important to note that not all IPOs include the sale of existing shares. Some IPOs may consist solely of newly issued shares, particularly if the company does not have a significant number of existing shareholders looking to sell their holdings.
Overallotment Option: Greenshoe
In certain cases, underwriters may exercise an overallotment option, also known as a greenshoe option. This provision allows underwriters to purchase additional shares from the issuing company after the IPO has been completed. The purpose of the greenshoe option is to stabilize the stock price in the aftermarket.
If demand for the IPO shares is exceptionally high and the stock price experiences a significant increase shortly after trading begins, the underwriters can exercise the overallotment option to buy more shares from the issuing company at the offering price.
By increasing the supply of shares in the market, the underwriters can meet investor demand and potentially dampen extreme price fluctuations.
The overallotment option is typically exercised within a specific timeframe, often 30 days after the IPO. The exact details of the greenshoe provision are outlined in the underwriting agreement between the issuing company and the underwriters.
IPO shares primarily come from the issuing company itself, with the majority being newly issued shares. The issuing company determines the number of shares to be offered and their price.
Underwriters play a vital role in facilitating the IPO process and purchasing shares from the issuing company, which are then sold to investors in the primary market.
In some cases, existing shareholders may choose to sell a portion of their holdings during the IPO, providing an opportunity for them to realize gains. Lock-up agreements often regulate the sale of existing shares to ensure price stability.
Additionally, underwriters may exercise an overallotment option, known as a greenshoe option, to purchase additional shares from the issuing company after the IPO. This provision helps stabilize the stock price and meet investor demand.
Understanding the sources of IPO shares is essential for investors looking to participate in these offerings.
By analyzing the mix of newly issued shares, existing shareholder sales, and potential greenshoe options, investors can make informed decisions about participating in IPOs and capitalizing on new investment opportunities.