Lock-in Period in an IPO

The IPO lock-in period for anchor investors is 90 days for 50% of shares and 30 days for the rest. For non-promoters, it's now reduced to 6 months from 1 year.
Lock-in Period in an IPO
3 mins
19-December-2024

An IPO lock-in period restricts certain shareholders from selling their shares for a specified period after the IPO, aiming to prevent market volatility. For instance, promoters typically face a one-year lock-in. Common types of lock-in periods include those for promoters, pre-IPO investors, and employees, contributing to post-listing stability.

What is lock-in period in IPO?

When a company goes public through an IPO, certain investors are restricted from selling their shares for a specific period, known as the lock-in period. This period typically lasts six months but can extend up to a year, depending on the investor category and regulatory guidelines. The lock-in period aims to stabilize stock prices and reduce the risk of significant sell-offs immediately after the IPO listing. It ensures that major investors, particularly promoters and anchor investors, hold their shares for a designated period, contributing to the company's long-term growth.

The lock-in period for an IPO is usually set at six months. However, it can be extended to one year. During this period, investors are not permitted to sell their shares.

The purpose of a lock-in period is to stabilize a company's share price before its investors can sell their holdings. This encourages long-term investors who are committed to the company's growth, rather than short-term investors seeking quick profits.

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Types of lock-in periods

Types of lock-in periods specified by SEBI are:

  1. 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.
  2. 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.
  3. 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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Frequently asked questions

What is the cooling-off period of an IPO?

During cooling-off period, the Securities and Exchange Commission (SEC) reviews the registration statement and no sales can take place. The cooling-off period typically lasts at least 20 days.

How long after the IPO are options available?
Investors get the options within a few weeks after an IPO becomes public. However, it can sometimes take 30-60 days before a stock is made eligible for options.
Is there any locking period for IPO?

The lock-in period for an IPO is typically six months, but it can be extended to one year. During this period, investors are not permitted to sell their shares.

The purpose of a lock-in period is to stabilize a company's share price before its investors can sell their holdings.

What is IPO lock-in period for retail investors?

The lock-in period for an IPO is typically six months, but it can be extended to one year. During this period, investors are not permitted to sell their shares.

How long is lock-up period after IPO?

The lock-up period for IPOs varies depending on the company and the type of investor. Typically, retail investors have a shorter lock-in period compared to promoters, directors, and institutional investors. Promoters and directors may face significantly longer lock-in periods, often extending up to a year or more. The purpose of these lock-in periods is to maintain investor confidence and prevent insider trading.

What does "lock in period" mean?

A lock-in period refers to the timeframe during which an investment or invested amount cannot be withdrawn or sold. This period is commonly applied to Unit-Linked Insurance Plans (ULIPs) and mutual funds.

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