IPO Lock-In Period: Meaning, types and How it works

The lock-in period in an IPO refers to the regulatory/contractual restriction that prevents promoters, early investors, and company insiders from selling shares during a specific period. This comes into play once the company goes public. Let us learn more about it below. 

What is a Lock-in Period in IPO

The IPO lock-in period is a regulatory or contractual restriction that prevents promoters, company insiders, and early investors from selling shares for a specified period after the company goes public or completes its IPO. This also helps stabilise share prices by mitigating any sudden influx of supply into the market. Here are some key aspects about lock-in periods for IPOs. 

• Objective: To prevent any early investors (venture capital, employees, founders, etc.) from immediately selling shares after the company listing and thereby tanking the prices of the stock. 
• Usual Duration: Mostly 6-12 months, although it may be longer in some cases. 
• Key Timelines for Stakeholders: In India, the minimum promoter contribution stays locked for 18 months, with others often for 3 years. For anchor investors, it is 30 days for 50% of the shares and 90 days for the remaining 50%. It is often 6 months from the listing date for pre-IPO investors or employees. 
• IPO Lock-In Expiry Impact: When the lock-in expires, the stock becomes more liquid. Heavy sell-offs upon expiry may also lead to a considerable drop in the stock price. 

Let us look at a few examples to help you understand what actually happens in such cases - 

1. Post-Listing Stability: Imagine an IT company going public. In this case, the lock-in requires the founders to hold their shares for 6 months. This makes them more committed to the company's growth and enhances investor confidence. 
2. Lock-In Expiry Price Drop: Now, imagine a huge drop in the share price of a leading technology company 6 months after the IPO. This is because private equity investors are now selling off their restricted shares immediately after the lock-in expiry, thereby enhancing the overall supply. 
3. Anchor Investor Lock-In: Suppose a big bank invests in a company before it lists, with a 90-day lock-in. This prevents them from dumping any shares on Day 1 after listing, although they may sell off considerably after this period expires. 

Why Does a Lock-in Period Exist

Here are some key reasons why a lock-in period exists after the shares are listed in the market -

• Price Stabilisation and Market Stability: This prevents immediate oversupply of shares after listing. It may otherwise have led to higher volatility or a sharp price plunge. 
• Boosting the Confidence of Investors: Knowing that early institutional investors and promoters are locked in will always boost retail investor confidence. This indicates that they believe in the company's long-term growth. 
• Combating Insider Dumping: It prevents insiders, such as company employees, founders, and venture capital investors, from dumping shares and cashing out immediately after a potential price surge. It may seem like a lack of faith in the entity if allowed to happen. 
• Maintaining Orderly Market Conditions: This lock-in period allows more time for a legitimate public market price to be discovered and then established (without being bogged down by insider selling pressure). 

Who Does the IPO Lock-in Period Apply To

Here are the main entities subject to the lock-in period once the IPO is listed - 

• Promoters: The lock-in period for promoters is 18 months, with a minimum 20% contribution. Furthermore, for any excess holdings, the lock-in period begins on the date of allotment and is set at 6 months.
• Pre-IPO Investors: The lock-in period (venture capital, private equity, and other non-promoter shareholders investing before the IPO) for pre-IPO investors is 6 months from the listing date. 
• Anchor Investors: The lock-in period for anchor investors is 30 days for 50% of their shares and 90 days for the remaining 50% (from the allotment date). 
• Employees: Shares allotted under ESOPs before the IPO may have a lock-in period of about 6 months. 

Lock-in Period for Retail Investors in an IPO

There is no lock-in/lock-in periods in IPOs for retail investors. They are free to sell their shares as soon as the stock gets listed on the stock exchange. Hence, if you were wondering if retail investors sell IPO shares on the listing day, the answer is yes. This exemption enables retail investors to liquidate holdings immediately after the listing. They do not have any mandatory holding period and get complete freedom to sell shares. At the same time, there is no lock-in for this category when it comes to SME IPOs as well (and not just mainboard IPOs).  

What Happens When the Lock-in Period Expires

This is what may happen when the IPO lock-in period expires: 

• Higher Supply & Possible Price Drops: In case many early investors or employees wish to cash in on their holdings, it may lead to higher supply and a price drop. 
• Higher Volatility: The market often anticipates selling pressure. This may lead to price volatility just before and immediately after the expiry date. 
• Insider Profit Booking: Founders, employees, and venture capitalists who purchased shares before the IPO may sell them to take profits or diversify their portfolios. 
• Indicator of Confidence: If major investors, such as promoters, hold on to their shares after restrictions end, it is seen as a sign of confidence in the company. This may support the share price as a result. 
• Market Sentiments: Selling pressure may be minimal if the company has done well. However, if it underperforms by the expiry date, it may trigger a massive sell-off. 

Does Lock-in Expiry Always Imply a Fall in Share Price

No, the lock-in expiry does not always equate to a fall in the stock. While the expiry of this period often leads to higher volatility and a greater likelihood of a short-term price drop, it is not guaranteed. Here are some reasons when it might not happen: 

• Priced In trend: Since the lock-in date is publicly known, traders may sell in anticipation of the expiry, leading to a price drop before the actual expiry date. If it happens, the main day of expiry may witness negligible downward movement. 
• Confidence of insiders: If the founders and early investors have confidence in the company, they may choose not to sell their shares. It supports the price and indicates a positive outlook for the market. 
• Short Squeeze: If the pre-expiration sell-off is excessively aggressive, traders shorting the stock may cover their positions on the day of expiry. It may otherwise lead to a short-term increase in prices. 
• Higher Liquidity: The end of the lock-in will mean more shares are available for trading. Higher liquidity may make the stock more attractive for big institutional investors, thereby enabling long-term price support. 

How Can Retail Investors Track Lock-In Expiry

This is how retail investors can track lock-in expiry:

• Carefully read the Red Herring Prospectus (RHP): It is the most accurate source for identifying when the lock-in period concludes for anchor investors, promoters, and early employees. 
• Use financial dashboards: Track specialised financial sites and apps that offer IPO calendars and list lock-in expiry dates. 
• Track trading volumes: Look for unusual spikes in volume 180 days (or the particular time frame) after listing. This indicates pre-sale positioning or higher institutional selling. 
• Use broker tools/platforms: You can utilise various broker tools or widgets to track IPO events, including the key expiry dates. 

Here is why tracking is important: 

• Supply shocks: Whenever lock-ins expire, a large volume of shares becomes eligible for sale, thereby leading to high supply. 
• Volatility in prices: The sudden availability of shares often leads to a drop in stock prices due to profit-taking by early investors. 
• Investor confidence: In case large shareholders hold onto their shares after the expiry of the lock-in period, it may indicate long-term confidence in the entity. 

Conclusion

The IPO lock-in period matters immensely and should be carefully tracked by investors. Watching out for the lock-in expiry date is essential, as it can lead to price drops and increased volatility.