Investing 101

What Investors Need to Know about IPO Lock-Up Periods

IPO overlayed on dollars

When it comes to investing in recent IPOs, it’s useful to know about IPO lock-up periods. Traditional IPOs come with a wide range of trading rules and restrictions. These are in place to protect investors and provide some trading stability.

To start, let’s look at a short definition for IPO lock-up periods. Then below that, you’ll find where to find lock-up agreement details, as well as why they’re used. They’re important for investors to consider…

What is an IPO Lock-Up Period?

An IPO lock-up period prevents company insiders from selling their shares for a period of time. In other words, the shares are “locked up.” This usually applies to a company’s founders, owners, managers and employees. In addition, it can apply to venture capitalists and other pre-IPO investors.

You’ll often see lock-up periods between 90 and 180 days. Most trading restrictions are lifted after the IPO lock-up period is over. Although, each deal is a little different. So, before investing, it’s good to read the fine print…

Why Use Lock-Up Periods?

The IPO lock-up period reduces selling pressure. This is because a stock is usually highly volatile for the first few months after a public offering. By making the earlier investors wait, there’s more time for the share price to stabilize in the market.

A lock-up period also prevents investors from flooding the market with too many shares when a company goes public. Typically, inside investors buy their shares at a lower price than the IPO price. As a result, they may be more inclined to sell their stocks after an IPO, which could harm the company’s success. For example, a major shareholder selling their holdings right after the company’s debut could cause its stock price to fall.

[Breakthrough: Ever Heard of the “Alpha Profit Code”?]

To reduce selling pressure and flooding the market, investment banks that underwrite the IPO typically require a contractual lock-up period. Here’s where you can find the details for a lock-up agreement…

Finding Lock-Up Agreement Details

You should determine whether the company has a lock-up and when it expires before investing in a company that has just gone public. You can find this info in a company’s prospectus. This is a filing with the Securities and Exchange Commission (SEC). It gives deep insight into the company that’s going public.

You can search for public company filings on the SEC.gov website. In the U.S., companies going public file an S-1. However, the government requires foreign companies listing in the U.S. to file an F-1 form.

You should know that IPO lock-up periods aren’t mandated by the SEC or any other regulatory body. Instead, a lock-up period is usually self-imposed by the company undergoing an IPO or required by the underwriters of an IPO.

Less traditional IPO methods have become increasingly popular in recent years. For example, many companies now opt to go public via SPACs. However, there is also a lock-up period for SPAC IPOs that differs from a traditional IPO…

Lock-Up Period for SPAC IPO vs. Standard IPO

There’s been an increase in special purpose acquisition companies (SPAC). However, you should know that the lock-up period can be longer for a SPAC IPO than a traditional IPO. SPAC IPO lock-ups generally last 180 days to one year, compared to the 90 to 180 days for standard IPOs.

[First Look: Man Who Crushed S&P in ‘20 Says Buy This for ‘22]

However, SPAC sponsors and a company’s shareholders are subject to different lock-up periods. According to Legal Scale, most of the SPACs from 2019 and early 2020 revealed that SPAC sponsors are often subject to a one-year lock-up period. Conversely, a target company’s shareholders often agree to a 180-day lock-up period.

Despite that, there are variations to lock-up periods. SPAC sponsors might be subject to shorter lock-up periods if certain pricing triggers are met and the company’s stock price reaches certain levels.

For example, this happened when DraftKings merged with SPAC Diamond Eagle Acquisition Corp. (DEAC). Initially, the founders and directors of DEAC were subject to a one-year lock-up period. However, the stock traded at over $15 for 20 out of 30 consecutive trading days. Therefore, the conditions of the lock-up agreement were met, and the lock-up period shortened.

Lock-up periods are almost always enforced for companies going public. However, some companies avoid lock-up periods by direct listing. Let’s take a look…

Avoiding Lock-Up Periods with Direct Listing

In recent years, a less traditional IPO method has gained more popularity. Some companies will enter the public markets through the direct listing process.

In a direct listing, a company sells shares directly to the public without the help of intermediaries. In other words, there are no traditional underwriters involved. It skips the bank-backing steps of a traditional IPO. Additionally, only existing shareholders sell their shares on the public exchanges. There are no additional shares offered to the public.

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A direct listing is a way for a company to make a public debut with no lock-up restrictions. In addition, some companies opt for direct listings because they can expedite the process for going public. Although, going public through a direct listing is often ideal for established companies with a loyal client base. These companies are usually popular among investors and don’t need added exposure.

What Happens After the IPO Lock-Up Period Expiration?

Since investors know the lock-up period in advance, they can also plan accordingly. 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.

After a lock-up period expires, the restrictions preventing insiders from selling shares lift. Insider investors can then sell their shares after the IPO lock-up period expires. However, it varies for every IPO. And sometimes corporate insiders cannot sell their shares after the lock-up period has expired. Due to the fact that they have substantial, nonpublic information, a sale would constitute insider trading.

The Final Line on an IPO Lock-Up Period

A lock-up period won’t usually prevent individual investors from selling shares since they don’t work for the company and didn’t receive shares as compensation. Despite this, lock-up periods can still affect you in the long run.

Since a company’s stock price usually dips at the end of a lock-up period, remember to do your research before investing. Often around the expiration of the lock-up period, investors can take advantage of the decline in stock prices to “buy the dip.” Moreover, not only can you take advantage of a potential price drop, but you would also prevent losing money if the stock loses value.

This is just one piece of the puzzle to going public.

However, make sure you do your research before investing. It’s important to keep track of when corporate insiders sell their shares. This might be an indicator that the company is not worth investing in.

[First Look: Man Who Crushed S&P in ‘20 Says Buy This for ‘22]

Read more from Aimee Bohn at InvestmentU.com

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