An initial public offering (IPO) lock-up period is a contract provision preventing insiders who already have shares from selling them for a certain amount of time after the IPO. Although the waiting period varies on a case-by-case basis, it typically ranges from 90 to 180 days. Investors should also note that the lock-up period is usually longer for special purpose acquisition company (SPAC) IPOs. Lock-ups for SPAC IPOs typically last 180 days to one year.
Lock-up periods generally apply to insiders, such as a company's founders, owners, managers, and employees. However, it may also apply to venture capitalists and other early private investors.
- An initial public offering (IPO) lock-up period is a contract provision preventing insiders who already have shares from selling them for a certain amount of time after the IPO.
- A standard IPO lock-up period typically ranges from 90 to 180 days, while lock-ups for SPAC IPOs normally last 180 days to one year.
- The chief purpose of an IPO lock-up period is to stop large investors from flooding the market with shares.
- Lock-up periods are not required by the Securities and Exchange Commission (SEC) or any other regulatory body.
- Investors can sometimes save money by waiting until the lock-up period expires before buying the shares of a newly listed company.
Reasons for IPO Lock-Up Periods
The chief purpose of an IPO lock-up period is to stop large investors from flooding the market with shares, which would initially depress the stock's price. Simply put, company insiders tend to own disproportionately high percentages of stock shares compared to the general public. Consequently, their high-volume selling activities could drastically impact a company's share price immediately after the company goes public.
Lock-up periods can also eliminate the appearance that those closest to the company harbor a lack of faith in its prospects. Sometimes, insiders simply wish to cash in on long-anticipated profits. Unfortunately, that could create false perceptions that negatively impact the company for no legitimate reason.
Insiders might still be prevented from selling their shares after the lock-up period expires. That can happen when an insider has access to material, nonpublic information, where the sale of shares would legally constitute insider trading. Such a scenario might occur if the end of the lock-up period coincided with the earnings season.
Legal Status of IPO Lock-Ups
It should be noted that lock-up periods are not mandated by the Securities and Exchange Commission (SEC) or any other regulatory body. Instead, lock-up periods are either self-imposed by the company going public or required by the investment bank underwriting the IPO request. In either case, the goal is the same: to keep stock prices up after a company goes public.
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).
Always investigate the lock-up period before investing in an IPO.
Many investment professionals, including Jim Cramer, sometimes recommend that investors wait for the lock-up period to expire before investing in newly listed companies. While new stocks can just keep going up during some bull markets, the market is not always favorable to IPOs. In less favorable environments, new stocks often fall in price when insiders unload their shares at the end of the lock-up period. Investors can then sweep in and get shares of the relatively new company at a discount. The chances of getting a bargain this way increase when insiders have large stakes in the company.
Waiting for the lock-up period to end also gives investors more time to consider the stock's performance. Did it drop right out of the gate? If so, it might be a good idea to invest in something else entirely. If the stock was looking good until the lock-up period expired, then it might still prove to be a sound investment.
The IPO lock-up period also has some interesting implications in the options market. Options are not available on the day of the IPO. However, they often become available for large and even midcap companies before the IPO lock-up period expires. If investors are nervous about a potential decline in the stock after the lock-up period ends, they may be able to buy protective puts. Speculators may prefer to simply buy calls or puts, depending on which direction they expect the stock price will go.
Real World Example
Perhaps the most high profile example of a lock-up period occurred with Facebook. After its May 18, 2012, initial public offering, the lock-up prevented the sale of 268 million shares during the company's first three months of public ownership. Facebook's stock price plummeted to an all-time low of $19.69 per share the day its first lock-up period ended. That is about 50% lower than the company's share price on the day the company went public. Interestingly, Facebook imposed stricter-than-normal restrictions that prevented the sale of another 1.66 billion shares through mid-2013. All told, Facebook's atypical lock-up policy released insider shares at five different dates.