IPO Lock-Up Definition
An IPO lock-up, also known as a lock-up period, is a contractual document designed to prevent early insiders and investors from selling their shares after a company going public. It helps to minimize pressure during the initial stages of a publicly-traded business. The lock-up period lasts for about 90 to 180 days, and the trading restrictions stop to exist once the period elapses.
A Little More on What is an IPO Lock-Up
What lock-ups do is to prevent immediate liquidation of assets by insiders once a company goes public. When pre-IPO investors and employees receive their options or shares, there is a contract they sign with the issuing company that prevents them from trading their shares for the first 90-180 days after the company goes public.
Note that once the company is ready to go public, there is reaffirming of the underwriting bank regarding the current agreements in the new contracts. The move prevents a decrease in prices as a result of the market disproportionately increasing the supply.
Short Lockups vs. Long Lockups
It is the founders, venture capitalists, employees, and private investors who own most of the private companies. Early investors and employees usually prefer shorter lockups to help them cash out faster. On the other hand, the underwriting banks would always go for longer lockups so that they can prevent share price sinking and market flooding by insiders.
The reason why owners of private companies prefer companies to go public is because of the following:
- First, is to help in raising cash to enable the business to grow
- Secondly, is to ensure that they cash a portion of their investment to date
How Lockups Work
During the initial public offering, companies exercise options or receive stock. The issuing of stock to employees during the IPO process is to encourage investors to buy the company’s shares and to also stabilize the price of the stock after its initial listing.
The company uses its issuance of shares to employees to show potential investors in the market that there is value in holding the stock. However, selling off company stock by key employees might not be beneficial to the company. Also, it is the duty of the company to ensure that it keeps the stock’s price high. To ensure this, the company will work on limiting or preventing the sale of the shares by these employees for a duration ranging from 90 to 180 days. That way is able to ensure that the price of shares does not go down.
Why Lockups are Important
When you look at the IPO lockup period from the company’s perspective, you will realize that extending payday is beneficial to the company. It helps it to stabilize the price of the stock or increase it even higher. So, the lockup period ensures that the employees holding the company shares when it is going public are made to wait until the end of the lockup period. By waiting, it is hoped that the price of the company’s shares will be selling at a favorable price by the time the lockup period comes to an end.
Note that when early investors or founders decide to retain a large number of their shares after public listing, it benefits the company. But, if they sell them immediately, then the move can really bring down the shares’ price, hence impacting negatively on both investors and the company.
So, the main idea behind the IPO lock-up period is to ensure that the pricing of the shares in the market follows a natural supply and demand. In other words, it prevents market volatility by supporting the price of the stock to ensure that they are stable after its initial listing in the market. It also ensures liquidity in the market.