Types of lock-in periods
Types of lock-in periods specified by SEBI are:
- In the case of investors: Anchor investors have a 90-day lock-in period on 50% of allotted shares. The rest of the 50% is locked in for 30 days after the allotment.
- In the case of promoters: The lock-in period is reduced to 18 months for allotment of up to 20% of post-issue paid-up capital from the previous 3 years. The second category is when the lock-in is reduced to 6 months for allotment exceeding 20% of post-issue paid-up capital from the previous 1 year.
- In the case of non-promoters: The lock-in period has been reduced to 6 months from 1 year for non-promoters.
Example of a lock-in period
Typically, promoter shares are locked for three years, while other pre-IPO investors face a six-month restriction. During this period, these shares cannot be sold, pledged, or transferred, contributing to market stability.
Exceptions may apply for specific purposes such as statutory requirements, employee stock options, or inter-promoter transfers, subject to regulatory approval and compliance with SEBI guidelines.
The prospectus must clearly disclose the lock-in details, including category-wise restrictions, applicable timeframes, and conditions for any early release of locked-in shares.
How does a lock-in period work?
When a company conducts an Initial Public Offering (IPO), it offers shares of stock to investors for the first time. During the post-IPO lock-up period, typically lasting six months to one year, these original investors are restricted from selling their shares. This allows the company to establish a stable market presence before shares become more widely available.
Although the stock price may fluctuate during this period, the lock-up restriction prevents original investors from realising gains or losses through immediate sales. Upon expiration of the lock-up, the stock becomes more liquid, enabling investors to buy and sell shares freely. Subsequent price movements will be influenced by market factors and investor sentiment.
Why is lock-in period needed in an IPO?
An IPO lock in period is a must because of the three main reasons mentioned below:
- Investment horizon: An IPO lock-in period ensures a long-term investment horizon. The lock-in period prohibits investors from selling their shares immediately.
- Raise capital: By initiating an IPO lock in period, companies stabilise and focus on consistency. This way, the share price of a company achieves balance and stability.
- Investors hold on to shares: By imposing an IPO lock in period, companies create a solid base of investors. The focus of investors is on growth and addition to profits instead of short-term gains.
The downside of a lock-in period
The lock in period for IPO has its own set of disadvantages. They are:
- False impression of demand for stocks: Investors cannot sell their shares during the IPO lock-in period. This creates a false impression about the accessibility of stocks in the market.
- Fall in stock price: Investors might experience a decline in the stock price once the lock-in period for IPO is over. Often, investors sell their shares to capitalise on gains. This oversupply of shares can lower their value.
- Reduced liquidity: During the lock-in period for IPO, investors cannot gain access to their funds. They might be restricted to address their financial needs and opportunities.
How to handle the end of a lock-in period?
Many factors must be considered once the IPO lock-in period is over. Selling shares immediately is not always the best option.
The four main factors to be considered are:
- Focus on long-term goals instead of the closure of an IPO lock-in period. If the company shows a consistent and prominent growth pattern, it is better to stay invested.
- Take advantage of the lowered share price. If the company records an increase in profit, you can repurchase them.
- Traders can sell and repurchase their shares once the price drop stabilises at a support level.
- Analyse the market sentiment. For instance, traders can opt for cheap call options if a price recovery is anticipated. Lower premiums in a bearish market are beneficial for traders.
Drawbacks of the IPO lock-in period
During the lock-in period, major investors are unable to sell their shares, even if they wish to. This can create a false impression of strong demand for the stock in the market. Retail investors may be uncertain whether anchor investors are genuinely committed to the company's long-term growth or simply waiting for the lock-in period to expire to sell their shares.
Another drawback is the potential for a sharp decline in the stock price once the lock-in period ends. If large investors simultaneously sell their shares to realise profits, it can lead to an oversupply of shares in the market, driving down the price. This sudden influx of shares can create a bearish sentiment among potential investors, as they may perceive it as a sign of waning confidence from early investors.
Conclusion
The lock-in period for an IPO is a mechanism that prohibits insiders from selling their shares as soon as they are offered. It prevents the market from oversupply of shares and stabilises the share price. An IPO lock-in period encourages long-term investment and changes the market sentiment, aiding the success of an IPO. Thus, consider the pros, cons, and lock-in periods before investing.
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