When a company goes public, it can open the door to new opportunities for investors who participated while the company was still private. Initial public offerings (IPOs) can be exciting, but they also come with complexities that existing investors may have to navigate. One of these complexities is called a lock-up period. In this blog, we’ll explore lock-up periods, their implications, and how investors can navigate them.
IPO Lock-Up Periods
What Are They?
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 stockholders, employees, owners, founders, and private investors, are prohibited from selling or redeeming their shares in a company after its IPO.
For those parties who could be very eager to cash out their shares upon an IPO, waiting for the lock-up period to expire can be especially tedious. However frustrating waiting may be, lock-up periods can be enacted for good reason.
How Long Do They Last?
Lock-up periods are not required by the SEC. Rather, they are usually self-imposed by the company going public. Often, the investment bank that is underwriting the IPO will include a lock-up period as a part of their contract. The length of the IPO lock-up period varies but typically lasts between 90-180 days, depending on the company. Once the lock-up period has expired, most existing shareholders are free to sell shares.
However, it can be important to keep in mind that not all lock-up period terms are the same. A company can change the terms of a lock-up period by negotiating with the underwriters of its IPO to potentially allow certain shares to be released earlier than the rest. Early release of shares could be negotiated from stock price thresholds being reached, decreasing market conditions, or financial need from the company. These terms are usually set up in the initial agreement unless there is justification for it to take place after the initial agreement.
What is its Purpose?
The main purpose of a lock-up period is to help 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 could be ready 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, could potentially lower the stock’s price per share.
What are the Risks?
The expiration of a lock-up period may create additional risk for the investors who hold the stock. The chance that the price could drop due to more shares entering the market or decreased demand for the shares can be a potential risk to investors. In addition to the previously mentioned risks, there may also be other risks that could affect investors. For example, having limited information like a lack of extensive price history and limited earnings information may feel like a risk to investors because they may not have the whole picture.
What happens when a lock-up period expires?
Typically, when a lock-up period expires, most, if not all, trading restrictions are removed. However, there can be some cases in which major shareholders are not allowed to sell their shares after a lock-up period expires. An example of this could be someone who has material, non-public information about the company may not be able to sell their shares immediately if the expiration corresponds with earnings season.
Impact on Investors
For investors, understanding the implications of lock-up expirations can be important. When shareholders are finally allowed to sell their shares, it can lead to increased volatility. Often, stock prices may dip as these shareholders cash in on their investments. Therefore, investors need to monitor lock-up expiration dates closely. Assessing selling trends and evaluating the company post-lock-up can also help provide information.
Do investors get paid out after the company IPOs?
Investors may qualify for returns once a company IPOs, but how and when investors can get paid out depends on different factors like their initial investments, fluctuations in the stock price, dividends, and the lock-up period. Investors can get paid out after an IPO by selling their shares or receiving dividends, depending on their investment strategy and the company’s financial decisions.
Are investors guaranteed to make money?
No, investors are not guaranteed to make money from a company’s IPO. Market sentiment, economic conditions, and investor perceptions all play a role in stock price fluctuations. In addition to the lock-up period, many other factors including the company’s performance can affect the stock price. Investments hold risk, so there is no guarantee that an investor could make money from a company going public.
Are there any scenarios in which there would not be a lock-up period?
While lock-up periods are very common when companies IPO, there still are times in which the company may opt not to have a lock-up period. In a strong market, or a bull market, a company may deem a lock-up period unnecessary because they believe the demand for their company’s shares could remain high enough to not need one.
Additionally, a company may attempt to form an intimate relationship with investors by allowing shareholders to sell their shares immediately. A move like this could show investors the company is confident in its future growth. Alongside this relationship, a high demand for shares during the IPO could also convince a company to skip a lock-up period.
While opting out of a lock-up period can signal confidence, it also carries risks, as immediate selling by stockholders can potentially lead to stock price volatility. Each company’s decision will depend on its specific circumstances and market environment.
Final Thoughts
While lock-up periods may feel frustrating to investors and shareholders, they can serve a valid purpose. Lock-up periods are put in place to help the company’s share price from being volatile due to a large number of shares entering the market quickly.
If an investor is interested in a specific company’s lock-up period, that information is made available to the public via the company’s S-1 filing with the SEC. If there are any updates to the lock-up period, they would also be announced via subsequent S-1As.
Want to learn more about initial public offerings? Check out the following MicroVentures blogs to learn more:
- The Initial Public Offering Landscape: What Investors Need to Know About an IPO
- Navigating Exit Strategies: IPOs, M&A, and Secondary Buy-Outs
- Demystifying IPOs: A Guide to Initial Public Offerings
- The Early Advantage: Investing Pre-IPO
- Is the IPO Window Opening Back Up?
Are you looking to invest in startups? Sign Up for a MicroVentures account to start investing!
*****
The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.
