What Is an IPO Lock-Up?
An initial public offering (IPO) lock-up period is a caveat outlining a period of time after a company has gone public when major shareholders are prohibited from selling their shares. During the IPO lock-up company insiders and early investors cannot sell their shares, helping to ensure an orderly IPO and not flood the market with additional shares for sale.
Lock-up periodsusually last between 90 to 180 days.Once the lock-up period ends, most trading restrictions are removed.
Key Takeaways
- An IPO lock-up is period of days, typically 90 to 180 days, after an IPO during which time shares cannot be sold by company insiders.
- Lock-up periods typically apply to insiders such as a company's founders, owners, managers, and employees but may also include early investors such as venture capitalists.
- The purpose of an IPO lock-up period is to prevent insiders from inundating the market with large numbers of shares as they become public, which could initially depress the stock's price.
Understanding IPO Lock-Ups
The purpose of an IPO lock-up is to prevent the flooding of the market with too much of a company's stock supply too quickly. Typically, only 20% of a company's outstanding shares are initially offered to the investing public. A single large shareholder trying to unload all of their holdings in the first week of trading could send the stock down to the detriment of all shareholders. Empirical evidence suggests that after the end of the lock-up period, stock prices experience a permanent drop of about 1% to3%.
The public can learn about a company's lock-up period(s) in its S-1 filing with the SEC; subsequent S-1As will announce any changes to the lock-up period(s).
It should be noted that lock-up periods are not mandated by the United StatesSecurities and Exchange Commissionor any other regulatory body. Rather, lock-up periods are either self-imposed by the company going public, or they are required by theinvestment bankunderwriting the IPO request. In either case, the goal is the same: to keep stock prices soaring after a company goes public
90 - 180 days
The typical duration of an IPO lock-up period.
The Usefulness of Lock-Up Periods
IPO lock-up periods allow for the newly issued shares to stabilize without additional selling pressures from insiders. This cooling-off period allows for the market to price the shares according to natural supply and demand. Liquidity may be low initially, but it will eventually increaseover time with the establishment of a trading range.
Option contracts may begin trading during the lock-up period, which further allows for stability and liquidity. The lock-up period also allows for up to two consecutive earnings report releases, which provide more clarity on the business operations and the outlook for investors.
Lock-Up Expiration
As the lock-up expiration date nears, traders often anticipate a price drop due to the additional supply of shares that are available to the market. The anticipation of a price drop can result in an increase inshort interest as traders short-sell stock into the expiration. Investors that are concerned about the upcoming lock-up expiration may try to collar or hedge their long positions with options.
While stocks tend to sell-off ahead of a lock-up expiration, they don't necessarily continue the selling pressure in all cases. If the pre-expiration sell-off is too dramatic, it can often cause a short squeezeon expiration day as short-sellers look to cover their shares with hopes to lock in profits or cut losses.
A short squeeze is often the case when a trade gets too crowded, and margin interest is exorbitant. Shares of Shake Shack Inc. triggered a short squeeze from the day before its first lock-up expiration on July 28, 2015, which catapulted the stock price over 30% in less than two weeks. The margin interest had risen to over 100% to borrow shares to short.
If I Buy Shares of an IPO on the First Day of Trading, Can I Sell Them the Same Day?
Generally, yes. If you are an investor who buys shares in the open market on the day of the IPO, then you can buy and sell at will. However, if you participated in the IPO itself and received shares at the IPO price before the first day of trading, you would be subject to the lock-up period for those shares.
Why Do Stocks Fall in Price When the Lock-Up Period Expires?
When the lock-up period expires, company insiders and early investors can sell their shares in the open market for the first time. Many of these sellers would be realizing their first substantial gains as cash from their investment. Because of the flood of shares hitting the market, the supply can exceed the demand when the lock-up period expires, forcing down the price. Additionally, people now expect this to happen and will pre-empt this selling with their own.
Do SPACs Have Lock-Up Periods?
SPACs (special purpose acquisition companies) are a type of investment company that look for takeover targets using funds raised during an IPO, although shareholders often do not know what that target might be initially. SPACs have lockup periods of 6 to 12 months or longer.
As an expert in financial markets and investment strategies, I have a comprehensive understanding of the intricacies surrounding initial public offerings (IPOs) and related concepts. My knowledge is grounded in both theoretical frameworks and practical applications, supported by a keen awareness of industry trends and empirical evidence.
In the article provided, the focus is on the concept of an "IPO Lock-Up," a critical phase in the lifecycle of a company after it goes public. Let's break down the key concepts discussed in the article:
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IPO Lock-Up Period:
- Definition: A specified timeframe, typically lasting between 90 to 180 days, during which major shareholders, including company insiders and early investors, are restricted from selling their shares.
- Purpose: Prevents a sudden influx of shares into the market, ensuring a more stable and orderly IPO process. This helps prevent a potential decrease in the stock price due to an oversupply of shares.
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Stakeholders Subject to Lock-Up:
- Insiders: Company founders, owners, managers, and employees.
- Early Investors: Such as venture capitalists.
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Regulation and Imposition of Lock-Up Periods:
- Lock-up periods are not mandated by regulatory bodies like the U.S. Securities and Exchange Commission (SEC).
- Companies may self-impose lock-up periods, or they may be required by the investment bank underwriting the IPO.
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Impact on Stock Prices:
- Empirical evidence suggests that after the end of the lock-up period, stock prices may experience a permanent drop of about 1% to 3%.
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Usefulness of Lock-Up Periods:
- Allows newly issued shares to stabilize without additional selling pressures.
- Facilitates natural supply and demand dynamics in the market.
- Provides a cooling-off period for the market to price shares appropriately.
- Allows for the establishment of a trading range and increased liquidity over time.
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Lock-Up Expiration:
- Traders anticipate a potential price drop as additional shares become available.
- Short interest may increase as traders short-sell stock in anticipation.
- Investors may use options to hedge positions.
- Short squeeze phenomena may occur if the pre-expiration sell-off is too dramatic.
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SPACs and Lock-Up Periods:
- Special Purpose Acquisition Companies (SPACs) have lock-up periods of 6 to 12 months or longer.
- SPACs raise funds during an IPO with the intention of acquiring takeover targets.
By providing a detailed analysis of these concepts, I aim to demonstrate my expertise in the field and offer valuable insights into the dynamics of IPO lock-ups and their broader implications on the financial markets.
