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What is an IPO Lock Up?
What’s important to know about it?
In this article, I will break down the meaning of an IPO Lock Up so you know all there is to know about it!
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What Is An IPO Lock Up
An IPO lock up refers to a period of time when major shareholders and key investors in a company are not allowed to sell their shares after the company goes public.
In other words, an IPO lock up is a restriction period on the sale of shares by major shareholders of a company that has gone public by initial public offering (IPO).
The objective of the lock up period is to ensure that the initial public offering process goes smoothly where major shareholders do not massively sell their shares creating panic in the market.
In most cases, the IPO lock up period can range from 90 to 180 days following which the restriction on the sale of shares is lifted.
Keep reading as I will further break down the meaning of an IPO lock up and tell you how it works.
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Why Is An IPO Lock Up Important
An IPO lock up is an important mechanism to ensure that IPOs are handled in an orderly fashion and investors are protected.
When a company offers its shares to the public, it’s important to keep the company insiders and major shareholders locked up in the company so they have a vested interest in ensuring that the business operations advance and remain profitable.
Otherwise, company founders, executives, key personnel, and major shareholders can sell their shares immediately upon the listing of the company’s shares leaving the investors with a company that is destined for failure.
Another reason why it’s important to ensure that important company insiders are locked up for a certain period of time is to prevent the company shareholders from flooding the market with new shares to sell.
If that were to happen, the market may panic leading to a sudden drop in share prices causing a financial loss to the new buyers and dissuading other market participants from investing.
Also, the market will have more confidence in a newly listed company knowing that its executives, founding members, and major shareholders remain onboard.
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How Does IPO Lock Up Work
First and foremost, it’s important to note that in the United States, the Securities and Exchange Commission does not impose companies to restrict the sale of shares following an IPO (except in the states that have adopted Blue Sky Laws).
Rather, the IPO lock up period is generally imposed by the investment banking firm underwriting the IPO.
In some cases, companies may self-impose a lock up period to remain consistent with market expectations.
The way the IPO lock up works is that a company will issue a certain number of shares to the general public.
Generally, about 20% of the company’s outstanding shares are publicly sold.
In the meantime, if the company adopts an IPO lock up period, you will be able to see it in its regulatory filings, particularly in the S-1 filing.
For example, if the lock up period is for 120 days, the sale restrictions will be lifted following that period.
Also, if the company makes a change to the lock up period, it will have to file an S-1A with the SEC to disclose the changes.
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IPO Lock Up Period Benefits
There are many benefits for investors when companies going through with an IPO have lock up periods imposed on their shareholders.
The first benefit is that following an IPO, company insiders are not able to sell their shares putting additional downward pressure on the stock price.
Also, since the company has recently gone public, there may be limited information on its business and financial operations.
During the lock up period, the market will have a chance to receive a few financial statements and disclosures about the company’s business allowing them to better assess the potential of the stock.
For the company and its shareholders, the lock up period protects them by allowing the company to maintain its stock price.
The more the company is able to maintain its stock price, the more profits the shareholders can potentially make if they choose to sell.
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IPO Lock Up Drawbacks
Although the IPO lock up period has clear benefits, there are also important drawbacks to consider.
For investors, the first drawback is that stock liquidity may be low.
As a result, if an investor is looking to sell shares, he or she may not easily find a buyer.
Also, there’s generally a dip in stock price once the IPO lock up period expires as some insiders may start selling their shares.
Since there is an expectation of traders short-selling the stock, on occasions such trading activities can lead to a short squeeze.
The short squeeze is caused by short-sellers looking to close out their position to cash in their profits or potentially limit their losses.
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IPO Lock Up FAQ
What is an initial public offering lock up period?
A lock up period following an IPO refers to the period of time that company insiders, investors, and employees are not authorized to sell their shares.
This means that major shareholders and key stakeholders in the company cannot immediately sell their shares as soon as the company stock is listed on a stock exchange.
How long is an IPO lock up period?
An IPO lock up period can vary in duration but is generally between 90 days to 180 days.
What’s more common is to see a 180-day lock up period following an IPO although it can be shorter.
The longer insiders are locked up following an IPO, the more they have an incentive to operate the company properly to maintain stock prices should they wish to cash out.
Why restrict the sale of stocks following an IPO?
Although an IPO lock up is not mandatorily required by law, in most cases, investment banking firms and underwriters will contractually impose it on the company insiders, investors, and employees.
In every company, there may be many employees or insiders that are looking to cash out their stock for a profit once the stock is listed.
However, if all the insiders and employees do the same thing, the stock will drop in value as the market will be flooded with additional shares.
The IPO lock up will prevent the stock price from dropping and preserve public confidence in the company.
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So there you have it folks!
What does an IPO lock up period mean?
In a nutshell, IPO lockups are legal restrictions imposed on company shareholders and insiders from selling their shares following an initial public offering (IPO).
The lock up period can be 90, 120, 150, or 180 days depending on the nature of the transaction.
When shares are offered to the public, the company will outline details relating to its lock up period in its IPO prospectus.
The main reasons why lock up periods are implemented are to ensure that the share price does not drop immediately following the listing of the shares and to protect investors against information asymmetry.
Now that you know what an IPO lock up is all about and how it works, good luck with your research!
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