IPO Lock-Up Period: What Investors Should Know
IPO stands for initial public offering, which comes with the most critical aspect of investment, i.e., lockup periods. When a company qualifies to go public, institutional and retail investors can be restricted from selling their stakes during the lockup period. Thus, investors are unable to cash out their investments during that period.
At some point after the IPO, the share prices experience volatility as the lockup period ends. So, it's crucial to understand the implications of the lockup period and how it affects your investment.
Topics Covered
- What is IPO Lock-Up Period?
- What is the Importance of the IPO Lockup Period?
- What Happens to the Share Price During and After the Lock-up Period?
- Conclusion
What is IPO Lock-Up Period?
An IPO lock-up is a period of time following an IPO, usually ranging from 90 to 180 days, during which business insiders are not permitted to sell shares. It aims to prevent insiders and early investors from selling their shares off for a specific period of time once companies release IPOs.
Founders take their firms public basically for two reasons:
- To obtain capital in order to expand their company
- To recoup a fraction of their initial investment
Some firms are able to compensate their teams with large stock awards. However, they don't want employees to sell a huge number of stock as soon as the company starts trading. Thus, they implement a lockup period.
What is the Importance of the IPO Lockup Period?
The lock-up period is imposed for several reasons, naming few of them as follows:
- Protecting the Share Price: It protects the share price by preventing investors from flooding the stock market with their sell-offs.
- Protect Public Investors: The pre-IPO investors may inflate the stock prices artificially while selling-off their shares without the implementation of lockup periods. Thus, it can protect public investors by determining the value of shares before investors are able to cash in their profits.
- Maintain a Stable Price: It is implemented to maintain a stable price, and that IPO has a positive impact on the company.
- Preventing Huge Sell-offs: By preventing huge sell-offs, IPO lock-up periods allow newly listed companies to acquire more investment & cash, facilitating the growth of the company.
What Happens to the Share Price During and After the Lock-up Period?
There is no definite answer to how the lock-up period affects the share price. Some stocks may prosper while some may struggle during the lock-up period. But, generally speaking, the stock price falls as pre-IPOs are sold by shareholders and supply of shares are increased in the stock market.
As investors anticipate this scenario very well, the share price starts declining well before the lock-up period expires. Here are the factors by which you can anticipate the share prices as the lock-in period ends:
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No. of Shares Locked
As the number of locked shares increases, there is a greater impact of the lockup period on share prices. The supply and demand theory of economics might cause the share price to decline as a result of this unexpected inflow.
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Owners of Pre-IPO Shares
It is crucial to understand the ownership of shares. The shares pertaining to its lock-up period may help predict if they will be selling down their position when it expires. There is a clear strategy behind each shareholder's position and why they own it.
For instance, founders, managers, and executives hold onto a large number of lock-up shares to maintain price stability. On the other hand, employees and institutional investors tend to sell a bulk of lock-up shares as soon as they are allowed to.
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Performance of Shares after IPO
If the stock’s value has increased since its initial public offerings, investors are more likely to sell those shares after the lock-up period ends. On the other hand, if it has decreased, they may not sell those shares and limit their exposure, mitigating a fraction of their losses.
The entry point is always lower than the IPO price. So, even if the share price plummets after listing, you may sell the shares at a profit.
Conclusion
The IPO lock-up period prevents company insiders from selling the shares as soon as they are offered. Hence, it protects the stock market from oversupplying of shares while also stabilizing the share price. The lock-in period allows investors to invest for longer periods, facilitating the chances of success of an IPO.
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Disclaimer: This blog is posted solely for educational purposes. The securities mentioned are examples and not recommendations. It is based on various secondary sources from the internet and is subject to change. Please consult an expert before making any related decisions.
