What is an IPO lock-up period and how do you trade it?
The lock-up period on a number of big-name shares – including Beyond Meat, Uber and Slack – is due to expire soon. We explain how to trade this opportunity.
What is an IPO lock-up period?
A lock-up period is designed to stop early investors and insiders from selling their shares for a set period once a company completes an initial public offering (IPO), helping to minimise selling pressure in the early stages of life as a publicly-traded business.
Private companies are typically owned by founders, employees, venture capitalists and private investors. There are two reasons why they take the company public. The first is to raise cash to grow the business. The second is so they can cash-in some of their investment to date.
Newly listed businesses decide how many shares to float, but it is not uncommon for founders or early investors to retain large stakes in the business after the IPO. If one or more of them decided to sell a large amount of their stock then this could seriously depress the share price, which is not in the interests of the company or any of its investors. Therefore, existing investors are often prevented from selling their shares for set period of time after the IPO has been completed, typically for 90 to 180 days.
Ultimately, lock-up periods are all about providing support to the share price, avoiding volatility and stabilising the market for shares in the initial months after listing.
What happens to a company’s share price after a lock-up period expires?
This means the largest shareholders in the business can only freely sell their shares after the IPO lock-up expiration. A flood of new shares can come onto the market if the owners of those shares decide to sell. If the share price has soared since the IPO, then early investors may want to reap the rewards by selling some of their investments, or if the price has tanked, then they may look to reduce their exposure. However, it does not mean they will sell either way as they could look to retain shares in the hope of prices heading even higher, or because they believe shares could recover any value lost in the early days as a public company. A lot of attention is paid to how the share price has performed versus the IPO price, but it is worth remembering that early investors are likely to have paid significantly less. This means many early investors will still be able to book a profit even if the share price has performed poorly after the IPO.
The end of a lock-up period sends a strong signal about the confidence the largest shareholders have in the company’s prospects. If institutional investors decide to dump the stock once the lock-up period ends, then this suggests they have little faith that the company is worth holding. If a relatively small number of shares are sold by these investors, then this shows they want to retain the shares and are bullish on the stock’s prospects.
Typically, if there is a sharp increase in the number of available shares available in a company then this pushes the price of a stock down. It is not unusual to see a stock’s share price fall on the first day that the lock-up shares can be traded. In fact, if other investors (not subject to the lock-up period) begin to sell in the days before the lock-up expires, then this is a sign that they expect the share price to fall.
However, there is also an argument that the end of a lock-up period can provide support after any immediate sell-off because it also means there is increased liquidity in the stock – which financial institutions and large investors like. Liquidity can be restrained during the lock-up period because it is not uncommon for the majority of a stock’s shares to be subject to it, which could mean they don’t initially meet the criteria demanded by the likes of institutions or pension funds.
Looking at 15 stocks that saw their lock-up periods expire in the first two weeks of October, the majority of shares started to fall in the days before the expiration date, prior to bouncing back three to five days afterwards. However, some saw virtually no selling pressure on the day and the share price immediately climbed once the lock-up had ended.
There is no definitive answer to how the end of a lock-up period will impact share prices. Every stock is different – some will suffer, others will benefit. What we can safely presume is that the end of a lock-up period will lead to increased volatility in the stock over the short term.
Pinterest and Zoom share prices both fall after lock-up period expires
Pinterest shares closed at just under $27 per share on Friday 11 October – nearly 42% higher than its IPO price of $19. However, shares began to lose value when the new week began and lost 3.8% by the time trading closed at the end of Monday 14 October – the day before the lock-up period expired. The following day, when lock-up shares could be freely sold, shares lost as much as 4.9%. However, they recovered much of that loss by the end of the day and closed 1.1% lower than the day before.
Zoom shares also began to lose ground the day before the lock-up period expired, losing about 0.8%. Shares fell by as much as 3% the following day once the lock-up expired, but ended the day up by 0.4%. However, there was an even sharper sell-off the day after the lock-up expired, with shares plunging by more than 6%. One reason Zoom’s share price could have suffered more than Pinterest’s is the fact that shares had almost doubled between the IPO and the lock-up period expiring, enticing more of its investors to cash in.
Both examples suggest that the end of a lock-up period does place very short-term selling pressure on a stock as expected.
Another worthwhile (but different) example would be Jumia Technologies, which unlike Pinterest and Zoom had seen its share price roughly half between launching its IPO and the end of its lock-up period on 9 October. Again, shares began to fall in the days before the lock-up period expired and saw that accelerate when it ended. Jumia shares plunged by nearly 18% over the four days from the lock-up expiring – hitting an all-time low. But shares have bounced back since and recovered those losses, supporting the theory that the end of a lock-up period does place short-term pressure on a share price but can help provide support thereafter.
How to forecast the effect of a lock-up period expiring on the share price
How does the share price perform in the days before the lock-up period expires? This usually shows how other investors expect the expiration of the lock-up period to impact the share price.
How has the share price performed since the IPO? If shares have rallied since listing, then this could entice investors to sell shares once the lock-up period expires. If it has tanked then this could discourage them from selling, but it could also entice them to reduce their exposure and cut some of their losses. Remember, their entry point will be lower than the IPO price, so they can still sell at a profit even if the share price has performed badly since listing.
How is the business performing? Many of this year’s largest IPOs have been companies that have questionable business models, such as Uber, which has confessed it may never be profitable. In the current climate where uncertainty reigns supreme, investors are looking for safer bets and have less of an appetite for riskier investments like high-growth but unprofitable businesses. This could encourage a larger sell-off once the lock-up period expires as investors look to redeploy their cash to safer alternatives. Remember, lock-up investors have not been able to respond to any news since the IPO.
How many shares are subject to the lock-up period? The number of shares subject to a lock-up is usually quite large. Take SciPlay as an example. Currently, only 22 million shares are freely tradeable in the business on the open market. But once the lock-up period expires on 30 October, a staggering 104.3 million more shares can be freely traded. The more of a company’s share capital that is subject to the lock-up period, the greater the potential selling pressure will be.
Who owns the shares subject to the lock-up period? Understanding who owns the shares subject to the lock-up can provide further insight as to whether they will look to sell down their stake when it expires. Consider the strategy behind each shareholder’s stake and why they own it. For example, if the majority of lock-up shares are owned by founders and management, then they are less likely to sell large stakes compared to institutions or funds that have invested early on. If employees have been paid in shares, then they will cash in at the first opportunity.
How to trade upcoming IPO lock-up periods
There are a few ways to trade the expiration of a lock-up periods following an IPO. If you believe the stock is going to suffer as a result of the lock-up period expiring, then you could short the stock in the days beforehand. You could do this using an IG’s CFD services, which also allow you to utilise leverage.
For investors, it could present a different opportunity. If you missed out on buying any shares when a stock conducted its IPO, or feel like you have been priced out, then any knock to the share price when the lock-up period expires could present an opportunity to buy at a cheaper price. This only applies if you believe in the stock over the long term and want to get a cheaper entry point.
Upcoming lock-up period expiration dates
A number of stocks have listed over the past six months and many investors are still unable to sell their shares due to lock-up periods. Below is a table outlining upcoming expiration dates for stocks that you can trade with IG. It lists the date the stock listed, the IPO price, and the date that the lock-up period will expire.
|IPO date||IPO price||Lock-up expiration date|
|Beyond Meat||5 May 2019||$25||29 October 2019|
|SciPlay||5 May 2019||$16||30 October 2019|
|Parsons||8 May 2019||$27||4 October 2019|
|Cortexyme||9 May 2019||$17||5 November 2019|
|Sonim Technologies||10 May 2019||$11||6 November 2019|
|Uber||10 May 2019||$45||6 November 2019|
|Applied Therapeutics||14 May 2019||$10||11 November 2019|
|Avantor||17 May 2019||$14||13 November 2019|
|Fastly||17 May 2019||$16||13 November 2019|
|Luckin Coffee||17 May 2019||$17||13 November 2019|
|Ideaya Biosciences||23 May 2019||$10||19 November 2019|
|Rattler Midstream||23 May 2019||$18||19 November 2019|
|GSX Techedu||6 June 2019||$10||3 December 2019|
|Revolve Group||7 June 2019||$18||4 December 2019|
|CrowdStrike||12 June 2019||$34||9 December 2019|
|Mohawk Group Holdings||12 June 2019||$10||9 December 2019|
|Fiverr International||13 June 2019||$21||10 December 2019|
|Chewy||14 June 2019||$22||11 December 2019|
|Grocery Outlet||20 June 2019||$22||17 December 2019|
|Personalis||20 June 2019||$17||17 December 2019|
|Slack||20 June 2019||$38||17 December 2019|
|Adaptive Biotechnologies||27 June 2019||$20||24 December 2019|
|RealReal||28 June 2019||$20||25 December 2019|
|DouYu International||17 July 2019||$12||13 January 2020|
|Genmab||18 June 2019||$18||14 January 2020|
|Medallia||19 July 2019||$21||15 January 2020|
|Castle Biosciences||25 July 2019||$16||21 January 2020|
|Health Catalyst||25 July 2019||$26||21 January 2020|
|Livongo Health||25 July 2019||$28||21 January 2020|
|Sunnova Energy International||25 July 2019||$12||21 January 2020|
|Borr Drilling||31 July 2019||$9||27 January 2020|
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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