Also known as a “locked-up,” “lock-in,” or “lock-out” period, a lock-up period is the timeframe in which existing shareholders, such as corporate insiders, employees, owners, founders, and private investors, are prohibited from selling or redeeming their shares in a company after its initial public offering (IPO).
For those parties who are likely very eager to cash out their shares and enjoy the fruits of their labor upon an IPO, waiting for the lock-up period to expire can be especially tedious. But, however irksome waiting may be, lock-up periods are enacted for good reason.
How long is the IPO lock-up period?
Lock-up periods are not actually required by the SEC. Rather, they are usually self-imposed by the company going public. Oftentimes, the investment bank that is underwriting the IPO will require a lock-up period as a part of their contract. The length of the IPO lock-up period varies and may be as little as 90 days or as much as 180 days, depending on the company. 180 is standard.
Of course, shareholders who are waiting to sell their shares hope for a shorter lock-up period, while the investment bank typically prefers a longer lock-up for reasoning we’re about to get into.
What is the purpose of a lock-up period?
The main purpose of a lock-up period is to mitigate share price volatility in the days and weeks following an IPO, allowing the market to find the stock’s “true” value. Naturally, companies prefer a high price and high demand for their shares.
When a company goes public, employees and private investors are often chomping at the bit to cash out the large number of pre-IPO shares they likely hold. A lock-up period is intended to prevent these eager shareholders from flooding the market with a mass influx of shares, which, due to the laws of supply and demand, would lower the stock’s price per share.
Whether it’s accurate or not, a large number of “insiders” selling their shares in a company may signal doubt over the company’s future prospects to the public. And for a company looking to bring in money from its IPO, that’s the last thing they want.
What happens when a lock-up period expires?
There are two common trends seen at the expiration of a lock-up period:
- The stock may decline rapidly due to the large influx of new shares; or,
- The opposite may happen, in which the public anticipation of the lock-up expiration prompts high performance the day of.
When the lock-up period expires, most trading restrictions are removed. However, there are some cases in which major shareholders may not be able to sell their shares after a lock-up expires. For example, someone who has material, non-public information about the company might not be able to immediately sell their shares if the expiration corresponds with earnings season.
While it is less common, some companies may choose to be even stricter with their lock-up period, Facebook’s 2012 IPO being an apt example. At the end of the company’s lock-up period, the share price dropped to $19.69, after ending at $38 at market close on opening day. This drastic dip prompted the company to prohibit the sale of an additional 1.66 billion shares all the way through 2013, after which insider share were then released gradually, across five different dates.
Too many shares entering the market too quickly could cause serious damage to a company’s share price, which is why lock-up periods are put in place. While they may be frustrating in the short-term, they serve a valid purpose.
If you’re curious about a company’s lock-up period, that information is made available to the public in its S-1 filing with the SEC. Any updates to the lock-up period are announced via subsequent S-1As.