ECM Explained: The IPO Process, Bookbuilding, and the Greenshoe Option

If you're interviewing for an Equity Capital Markets (ECM) role, or even a coverage group that works on IPOs, expect at least one question on how a company goes public. And the follow-up is almost always: "Walk me through how a greenshoe works."

This post walks you through the full IPO process, shows how bookbuilding actually sets the price, and breaks down the greenshoe with real numbers. By the end, you'll be able to explain all three clearly in an interview.

What ECM Actually Does

ECM is the group that helps companies raise money by selling equity. IPOs are the headline product, but ECM also handles follow-on offerings, block trades, and convertible bonds (often with a dedicated team).

ECM sits between two worlds:

• Coverage bankers, who own the client relationship
• Sales and trading / syndicate, who know what investors want and at what price

That middle position is why ECM bankers obsess over market conditions, investor demand, and pricing. Keep that in mind as we go through the process.

The IPO Process, Step by Step

A typical US IPO takes several months from kickoff to first trade. Here's the sequence you should be able to recite.

1. Choosing the Banks

The company picks a group of underwriters, called the syndicate. The most important are the bookrunners, and the lead "left lead" bookrunner runs the process.

Banks compete for these roles in a "bake-off," pitching their valuation view, research coverage, and investor relationships.

2. Due Diligence and Drafting

This is the longest phase. Bankers, lawyers, and accountants dig into the business and draft the registration statement (the S-1 for US domestic issuers).

The S-1 includes:

• Business description and risk factors
• Audited financial statements
• Management's discussion and analysis (MD&A)
• Use of proceeds and details on the offering

3. SEC Review

The company files the S-1 with the SEC, which sends comments back. There are usually several rounds of revisions.

Many companies first submit the draft confidentially, so competitors don't see the details until the company is closer to launching. The filing has to become public before the roadshow starts.

4. Setting the Price Range and Launching

Once the SEC process is mostly done, the banks set a price range (for example, $18 to $20 per share) and print the preliminary prospectus, nicknamed the "red herring" because of the red legend on its cover saying the information isn't final.

The range is based on valuation work (comparable companies, DCF) plus feedback from early investor meetings, often called "testing the waters."

5. The Roadshow

Management and the bankers pitch the company to institutional investors, mostly through one-on-one meetings and group presentations. Roadshows usually last about a week or two.

This is when bookbuilding happens, which we'll unpack in a minute.

6. Pricing and Allocation

On pricing night, the company and the bookrunners agree on the final offer price and decide which investors get how many shares.

7. Trading and Closing

The stock starts trading on the exchange, usually the morning after pricing. The deal closes shortly after, when the company receives its cash and investors receive their shares.

8. After the IPO

A few things kick in:

• Lock-up: existing shareholders (founders, employees, VCs) agree not to sell for a set period, commonly 180 days
• Stabilization: the underwriters can support the stock price, using the greenshoe (more on this below)
• Research coverage: analysts at the syndicate banks start publishing after a quiet period

Bookbuilding: How the Price Actually Gets Set

Here's the key idea: an IPO price isn't calculated, it's discovered. Valuation models give you a range, but investor demand decides where in (or outside) that range the deal prices.

How Orders Work

During the roadshow, institutional investors place indications of interest with the bookrunners. These aren't binding until pricing, but they signal real demand.

Common order types:

• Strike orders: "I'll take 500,000 shares at any price in the range"
• Limit orders: "I'll take 500,000 shares, but only up to $19"
• Step orders: "1 million shares up to $19, 500,000 shares up to $20"

The syndicate desk collects everything into the book and tracks it in real time.

Reading the Book

Bankers care about more than total size. They look at:

• Coverage: how many times the deal is oversubscribed. If the company is selling $200M of stock and orders total $1B, the book is 5x covered.
• Price sensitivity: how much of the demand survives at the top of the range, or above it
• Quality: long-term holders (big mutual funds) are worth more than investors likely to flip the stock on day one

Worked Example

Say a company offers 10 million shares with a range of $18 to $20.

With 4.5x coverage at the top of the range, the bankers have options:

• Price at $20, the top of the range
• Raise the range and price higher, say $21 or $22
• Upsize the deal by selling more shares

They won't push all the way to where demand barely covers the deal. Pricing at $22 with only 2x coverage leaves little cushion, and the stock could trade poorly once it opens.

Why Banks Leave Money on the Table

IPOs are usually priced at a discount to where the bankers expect the stock to trade. That's why you often see a "first-day pop."

Why do it on purpose?

• Rewards investors for taking a risk on an unproven public company
• Creates a strong debut, which helps the company with future offerings and its reputation
• Builds aftermarket demand, since investors who didn't get full allocations buy in the open market

The tension is real, though. A big pop means the company sold shares too cheaply. A great answer in an interview acknowledges both sides.

Allocation

Allocation is discretionary. The bookrunners don't just fill orders proportionally; they favor investors who:

• Did serious work during the roadshow
• Are likely to hold long term
• Placed orders early and at firm prices

The Greenshoe Option: The Part Everyone Gets Wrong

The greenshoe, formally the over-allotment option, lets the underwriters sell up to 15% more shares than the base deal. It's named after the Green Shoe Manufacturing Company, the first company to use it.

The underwriters usually have 30 days after the IPO to exercise it.

Its real purpose isn't to raise more money. It's to stabilize the stock price after the IPO.

Step 1: The Underwriters Go Short

At pricing, the underwriters allocate 115% of the base deal to investors. But the company has only agreed to sell 100%.

So the underwriters are effectively short 15% of the deal. They've sold shares they don't own yet.

This sounds risky, but the greenshoe makes it safe, because they now have two ways to cover that short.

Step 2: What Happens Next Depends on the Stock

If the stock trades up: the underwriters exercise the greenshoe and buy the extra shares from the company at the offer price. Short covered, no loss.

If the stock trades down: the underwriters buy shares in the open market to cover the short. That buying pressure supports the price. They don't exercise the greenshoe.

Either way, the underwriters are protected. That's the elegant part.

Worked Example

Base deal: 10 million shares at $20, so $200M gross. Greenshoe: 15% x 10 million = 1.5 million shares.

The underwriters allocate 11.5 million shares to investors and collect $230M. They owe the company money for 10 million shares and are short 1.5 million.

Scenario A: Stock rises to $25

• Buying 1.5 million shares in the market would cost $37.5M, way more than the $30M they collected
• Instead, they exercise the greenshoe and buy 1.5 million shares from the company at $20
• The company raises an extra $30M gross, for $230M total
• The short is covered at no loss to the underwriters

Scenario B: Stock falls to $18

• The underwriters buy 1.5 million shares in the market for $27M
• That buying helps hold the price up
• They don't exercise the greenshoe, so the company raises only the base $200M
• The underwriters collected $30M for those shares and spent $27M covering, so they make $3M on the stabilization trade

Scenario C: Stock trades in between

The underwriters can do a mix: buy some shares in the market to support the price and exercise the greenshoe for the rest. The option can be exercised partially.

Quick Note on Naked Shorts

Sometimes underwriters sell more than 115% of the deal. That extra amount is a naked short because no option covers it, so it can only be bought back in the market.

Underwriters only do this when they expect weakness and want extra firepower to support the price. If the stock rises instead, they lose money on that portion.

How the Banks Get Paid

Underwriters earn the gross spread, the difference between what investors pay and what the company receives.

For many mid-sized US IPOs, the spread has historically been around 7%, with large deals often paying less. On our $200M example at 7%:

• Gross spread = $14M
• Company receives $186M before other expenses

The greenshoe shares carry the same spread, so exercising it boosts fees too.

The spread is traditionally split into three pieces. A common rule of thumb is roughly:

• Management fee (~20%): for the lead banks running the deal
• Underwriting fee (~20%): for taking on underwriting risk
• Selling concession (~60%): for actually placing the shares with investors

Interview Questions You Should Be Ready For

Practice these out loud:

1. "Walk me through the IPO process." Hit the main steps: banks hired, diligence and S-1, SEC review, price range, roadshow and bookbuilding, pricing, trading, lock-up.
2. "How is an IPO priced?" Valuation sets the range, investor demand in the book sets the final price, and there's usually an intentional discount.
3. "How does a greenshoe work?" Underwriters over-allot 15%, creating a short. Stock up: exercise the option. Stock down: buy in the market, which supports the price.
4. "Why would a company want a first-day pop? Why not?" Good for reputation and future raises, but it means selling equity too cheaply.
5. "What's a lock-up and why does it matter?" It prevents insiders from flooding the market right after the IPO, and the stock can come under pressure when it expires.

The Bottom Line

The IPO process is a sequence you can memorize. Bookbuilding is where the real price discovery happens. And the greenshoe is a clever tool that lets underwriters support the stock without taking on risk.

If you can explain the greenshoe with a simple numerical example like the one above, you'll stand out from candidates who just say "it's a 15% option." Run through the scenarios a few times until they feel automatic, and you'll be ready when the question comes.