What’s an IPO Lockup? Definition, Purpose, Expiration Strategies

UTC by Ibukun Ogundare · 6 min read
What’s an IPO Lockup? Definition, Purpose, Expiration Strategies
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Here is everything you need to know about IPO lockups – what IPO lockups are, why they are crucial, and the typical exceptions to the standard lockup periods.

The shares of a company are often held by a number of key people prior to going public. The company’s founders, pre-IPO investors like venture capital companies, and its staff are all included in this group. An initial public offering (IPO) is one of the most thrilling things that can happen to a developing company. Traders may find it to be an exciting occasion. An IPO does not only include the introduction of new stock to the market but also includes an IPO lockup period that may offer trading possibilities. The procedure through which a private firm first sells shares on open stock markets is known as an initial public offering or IPO.

After a company’s IPO, a lockup period is meant to restrict early investors and insiders from selling their shares for a defined length of time. Although practically all IPOs have lockups, they are not mandated by any regulatory authority. In reality, the majority of underwriters want them, investors frequently avoid businesses without them, and most high-end legal firms insist on including them early in a company’s lifespan.

Any company considering going public must be aware of what IPO lockups are, why they are crucial, and the typical exceptions to the standard lockup periods. And any investor financially committing to a company must stay informed about the process. The fact that well-known companies’ stock values increase when they list on the market and spark public attention makes many individuals consider initial public offerings as substantial financial opportunities. The trendiness of IPOs is undeniable, but one must understand that they are extremely risky investments with variable long-term returns.

IPO Lockup Explained

A lockup period refers to the period following an IPO when large shareholders are prohibited from selling their shares. It is intended to prevent major investors from oversupplying the market with shares, possibly driving down the stock’s price. Simply put, as compared to the broader public, business insiders typically possess disproportionately high percentages of stock shares. Because of this, their high-volume selling operations may have a significant influence on a company’s share price just after the business goes public.

The duration of an IPO lockup period might vary depending on the business and the particulars of its IPO. The lockup period usually lasts between 90 and 180 days after the IPO, but it may be shorter or longer in specific cases.

What Happens Next?

Insiders frequently sell some of their shares after IPO lockups expire. The price of the shares might decrease as a result of the increased supply. Many investors may decide to sell their shares in the days before the expiration date in order to take advantage of this situation and avoid the price decrease that will follow. However, this behavior frequently causes the share price to fall days before the lockup’s expiration date in addition to doing so on that day.

As an illustration, the price of Uber’s stock fell 17% in 2019 as the lockup period was about to expire. Despite the fact that the company’s performance played a role in this as well, the impending lockup expiry was widely acknowledged as being a significant factor.

A lockup period’s conclusion is a clear indication of how optimistic the company’s top shareholders are about its future. When the lockup period expires, institutional investors may elect to sell off their shares, which indicates they do not think the firm is worth investing in. These investors are positive about the future of the company if only a small portion of their shares are sold, indicating that they intend to keep their holdings. At the conclusion of the IPO lockup period, selling pressure varies in intensity amongst companies. Insiders may be encouraged to hang onto their shares and sell them at a later time if the stock price is below the IPO price as a result of unfavorable news about the firm. Insiders could be impatient to sell if the stock price is high.

It is vital to remember that early investors are probably to have paid significantly less. The share price’s performance in relation to the IPO price is frequently highlighted. Insiders and substantial shareholders will be able to sell their shares once the IPO lockup period expires, which might cause the stock price to become more erratic. In the event that a large number of shares are sold, the stock price can drop. But if insiders opt to maintain their shares, it may be seen as a vote of confidence in the company, which would raise the stock price.

IPO Lockups: Gains and Risks

The freshly issued shares can stabilize throughout IPO lockup periods without further selling pressure from insiders. The market is given the opportunity to value the shares in accordance with supply and demand dynamics during this cooling-off phase. Due to the possibility of making money quickly, while these profits are not guaranteed, many investors opt to invest in initial public offerings.

For the shareholders who own the shares, the end of an IPO lockup period might bring about new risks. Even for initial public offerings that start off well, there is a potential that prices might decline as the lockup period’s expiration draws near. While insiders and other sellers start to sell as a lockup period is about to expire, more shares might reach the market. If demand for the shares declines at the same time that the supply of shares rises, prices may fall as a result.

Bottom Line

An IPO lockup period is the period following an IPO when insiders are restricted from selling their shares. Insiders are permitted to sell after an IPO lockup expires, and they frequently do so, which lowers shares prices by several percent.

Lockups are used to prevent insiders from selling off assets too quickly after a company’s IPO. It makes it less likely that a sudden wave of selling will cause the stock price to fall.

For newly issued public shares, the lockup period contributes to market entry price stabilization. The company may appear unprofitable to investors when corporate executives sell their shares to the public.

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FAQ

What is an IPO lockup?

An IPO lockup period is a time frame during which business insiders are prohibited from selling their shares on the open market. When there is a lockup period, it implies that following an IPO, stockholders, employees, and business executives are prohibited from selling or redeeming their shares. This occurs when a business issues its initial public shares.

Why do companies have IPO lockups?

The lockup period is sometimes instituted in order to avoid a sudden flood of shares into the market that would significantly lower the stock price. When there is a significant excess of shares available compared to demand, the stock will typically decline. In addition, IPO lockups prohibit insiders from leaving the market too soon. Basically, a lockup time is a method of safeguarding retail investors as a result.

How does an IPO lockup affect the stock price?

The conclusion of an IPO lockup period may have a major effect on a company’s stock price because in the event that many shares are sold, the stock price can drop. However, the market could view insiders choosing to hold onto their shares as a positive sign, which might lead to a rise in the stock price.

Can insiders sell their shares during the lockup period?

Typically, insiders, such as business executives, directors, and significant shareholders, are prohibited from selling their shares during the lockup period. This helps to ensure a smooth IPO and prevents the market from being oversaturated with shares for sale.

Are IPO lockups beneficial for investors and companies?

IPO lockups are beneficial to both investors and companies as both parties enjoy some kind of protection against avoidable price falls. This is because the lockup is the agreement that stops many insiders and early investors from selling their shares immediately after the IPO which may market demand and choke the shares price. Also, insiders and early investors selling shares due to no IPO lockups could indicate a lack of confidentiality in the company’s success, crumbling the entire business.

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