IPO lockups are not required by a regulating body, yet almost all IPOs include them. In fact, most underwriters demand them, investors will often shy away from companies without them, and most sophisticated law firms insist on including them early in companies’ lives. Any company considering going public must understand what IPO lockups are, why they are important, and the common exceptions to the traditional lockup periods. This article will cover the following topics.
IPO Lockup Overview
An IPO lockup is an agreement signed by those who own shares prior to an IPO (i.e., insiders and early investors). The agreement restricts these shareholders’ abilities to sell shares for a period of time—most commonly 180 days. These agreements are not required, except in states that require them via “Blue Sky Laws.”1 Information regarding a company’s IPO lockup restrictions can be found in the IPO prospectus.
Why Are IPO Lockups Important?
- Protect the share price from dropping immediately after the trade date
IPO lockups serve an important purpose in protecting the common investor, hence why they are so demanded. Without the lockup period, many insiders and early investors would sell their shares shortly after the IPO in an effort to gain liquidity. This flood of supply could overwhelm demand, thus depressing the share price, which hurts common investors who recently purchased shares in the expectation that the value would increase.
- Guard against information asymmetry
Additionally, IPO lockups can protect common investors by creating a period of time in which the health and profitability of the company is further revealed while insiders cannot sell shares. This restriction guards against potential information asymmetry, the condition that exists when insiders are making decisions based on information not yet available to common investors.
In a 180-day IPO lockup period, two quarterly earnings announcements occur. If negative information was hidden during the IPO process for the purpose of artificially boosting the initial share price—so that insiders could immediately cash in after the IPO, for example—these announcements would likely reveal that hidden information. This removes much of the motivation to hide negative information during the IPO process to “cash-in” before share prices plummet at the arrival of such news. By largely removing that motivation, the common investor has more confidence that the publicly available information at and immediately following the IPO date is accurate.
By guarding against potential information asymmetry, IPO lockups not only benefit common investors but also the IPO companies themselves. Most companies have nothing to hide from the public and the executives have confidence in the future of their companies. However, those optimistic owners may still want to sell shares after the IPO in an effort to gain liquidity. The public often interprets these insider sales as a lack of confidence in the future of the company. The share price would likely take a hit as the public assumes that there is some non-public bad news, even if that isn’t true. When insiders agree to a lockup period, they are in essence showing they are not only willing to “not only put their money where their mouth is but to keep it there as well” (Brau, “Lockups Revisited”).2
When IPO lockups expire, insiders tend to sell a portion of their shares. Because of the increase in supply, the share price may drop. In anticipation of this event, many investors will sell their shares in the days leading up to the expiration date to get ahead of the drop. However, this behavior often causes the share price to drop days before the expiration date in addition to dropping when the lockup actually expires. For example, in 2019 Uber experienced a 17% drop in their stock price in the days approaching its lockup expiration. Although this was partly due to the company’s performance, the upcoming lockup expiration was largely recognized as playing a major role.3
Exceptions to the Traditional IPO Lockup
SPAC IPOs also have lockup periods, similar to those of traditional IPOs. The main deviation is length. SPAC IPO lockup periods tend to be longer than the traditional lockup period, often stretching about a year.4 This allows time for the SPAC to find a target company to acquire.
Insiders can potentially circumnavigate IPO lockup restrictions by completing a seasoned equity offering (SEO), sometimes known as a secondary offering,5 during the IPO lockup period. SEOs are often a mix of newly issued shares from the company and personally owned pre-IPO shares owned by top executives. Executives can potentially sell a portion of their pre-IPO shares as part of an SEO that occurs during the IPO lockup period and circumvent the lockup period restrictions. However, if executives choose to take this route, they may meet alarmed or negative sentiment from outsiders and should be prepared with an explanation for their decision.
Although the typical IPO lockup period does not expire until its scheduled day, there are a few circumstances that justify early releases from the agreements. However, these early release provisions usually apply to only a percentage of the locked-up shares or to just a subset of “early release shareholders” rather than to the entire population of insiders.
Early release provisions have become more common in recent years. This increased flexibility may be tied to the rise in alternate methods of going public such as direct listings. Some of the most common circumstances are covered below.
In general terms, a blackout period is any period of time in which specific actions are restricted or prohibited at a company. In the context of trading shares, companies generally have blackout period policies that restrict specific groups of executives and employees from selling their shares for a period of time due to the potential existence of material insider information. If these blackout periods overlap with IPO lockup periods, the IPO lockup agreements will sometimes include early release provisions to prevent the two events from coinciding and elongating the IPO lockup period.
Specific-Event Blackout Periods
Sometimes these blackout periods are enacted because of specific, irregular events such as mergers and acquisitions. These specific-event blackout periods are not announced to the entire company nor to the public because of the highly confidential nature of the information. Simply knowing that a specific-event blackout period exists could spark speculation and lead to noteworthy drops or rises in a company’s share price. Instead, only the specific individuals involved with such information are privately notified that they cannot sell their shares until the information becomes publicly available.
Because these blackout events cannot be announced to the public and the dates of these specific events are typically unknown during the construction of the IPO lockup agreement, these specific-event blackout periods do not lead to early-release provisions in the IPO lockup agreements.
Quarterly Blackout Periods
Quarterly blackout periods caused by the quarterly earnings announcements are more common than specific-event blackout periods. Most often, executives, accounting and finance employees, and any other company personnel who may have access to the undisclosed information are prohibited from trading their securities for a period of time (usually a few weeks) before the quarterly earnings are announced each quarter.
These quarterly blackout periods have the potential to coincide with the IPO Lockup period expiration, which essentially elongates the lockup period. Because the quarterly blackout periods are regularly scheduled and the expected lockup period expiration date is also known, companies can anticipate if the two events will overlap. As such, the issue should be addressed in the initial agreement with the underwriters by establishing an earlier lockup period release date.
Pursuant to the lock-up agreements with the underwriters, if (i) at least 120 days have elapsed since March 28, 2019, (ii) the Company has publicly released earnings results for the quarterly period during which the IPO occurred and (iii) such lock-up period is scheduled to end during or within five trading days prior to a broadly applicable and regularly scheduled period during which trading in the Company’s securities would not be permitted under its insider trading policy (the “blackout period”), such lock-up period will end ten trading days prior to the commencement of such blackout period. The lock-up period is scheduled to end on September 24, 2019, which falls within the Company’s quarterly blackout period that commences at the end of the day on August 31, 2019. Therefore, in accordance with the lock-up agreements with the underwriters, the lock-up period will end at the open of trading on August 19, 2019, which is ten trading days prior to the commencement of the Company’s quarterly blackout period. The Company will also release the market standoff agreements when the lock-up period expires6
One of the most common early release provisions in IPO lockup agreements are price conditions. A price condition is a specific price set forth in the IPO lockup agreement that the company’s share price must reach for the company to experience an early release from the lockup period. The price is often expressed as a percentage increase from the initial public offering price (e.g., the share price must reach a price that is 25% greater than the IPO price).
Beyond the price condition, there are other specific conditions that must be met for this type of early release to trigger. Some of these conditions include the following:
- A specified number of days have passed since the IPO date. For example, many provisions specify that 90 days must have passed since the IPO date. This is commonly referred to as the “Early Expiration Threshold Date.”
- At least one quarterly earnings report has been filed since the IPO date.
- As discussed above, the price condition must be met. Generally, the agreement specifies that the most recently reported closing price must reach a price expressed as a percentage increase from the IPO price. (e.g., 25% greater than the IPO price).
- This price condition was not reached just once but the specified price was reached or surpassed for an extended period of time. For example, most provisions specify that the price milestone must be reached for at least 10 out of 15 trading days.
In summary, for an early release to be triggered from price condition fulfillment, a company must generally reach or surpass the price condition for a number of consecutive days after the “Early Expiration Threshold Date” has passed and at least one quarterly earnings report has been filed since the IPO date.
These lock-up agreements provide for early expiration of the Lock-Up Period in certain circumstances, including that the Lock-Up Period will expire with respect to 25% of the Vested Holdings (as defined below) held by each Early Release Holder (as defined below) on the date that is two trading days after the date that the closing price of the Company’s Class A common stock on the New York Stock Exchange exceeded 133% of $120.00, the initial public offering price of the Company’s Class A common stock in connection with the IPO, for at least 10 trading days in the 15-day trading period immediately following December 14, 2020 (the “Price Condition”).7
Early Expiration Threshold Date
Sometimes the Early Expiration Threshold date lands on a quarterly blackout period, which would prevent the early release. In these cases, the agreements almost always clarify that the Early Expiration Threshold date will be moved, generally to an earlier date, if the company meets all requirements for a price condition early-release leading up to the Early Expiration Threshold date.
Pursuant to the lock-up agreements with the underwriters, the restricted period will end with respect to 25% of the shares subject to each lock-up agreement if at any time beginning after September 15, 2020 (the “Early Expiration Threshold Date”) (1) the Company has filed at least one quarterly report on Form 10-Q or annual report on Form 10-K and (2) the last reported closing price of the Company’s ordinary shares is at least 33% greater than the initial public offering price of the Company’s ordinary shares for 10 out of any 15 consecutive trading days, including the last day, ending on or after the 90th day after September 15, 2020 (the “Price Condition”), provided that two business days’ notice of such release is reported on a Current Report on Form 8-K (the “Notice Condition”). The 90th day after September 15, 2020 is December 14, 2020, which day will be during a Company trading black-out period. The lock-up agreements provide that in such event, the earliest Early Expiration Threshold Date would instead be the sixth trading day immediately preceding the commencement of such trading blackout period, which day is November 20, 2020 [emphasis added]. On November 20, 2020, the Price Condition was satisfied, and as a result 25% of the shares subject to each lock-up agreement will become eligible for sale in the public market at the open of trading on November 25, 2020 (subject to trading limitations on shares held by affiliates of the Company, continued vesting of any unvested equity awards as of such date, and the Company’s insider trading policies). This Form 8-K is intended to satisfy the Notice Condition8.
Multiple IPO Lockups Periods
Some companies have multiple IPO lockup periods associated with their IPO. This arrangement is most common with larger IPOs, especially when the insiders own a large proportion of the shares. By staggering the lockup periods, the supply of new shares is introduced slowly rather than saturating the market after a single lockup period.
The first lock-up period (the “First Lock-Up Period”) will commence on the date of this Lock-Up Agreement and continue until six months after the IPO Date.
The second lock-up period (the “Second Lock-Up Period”) will commence upon the expiration of the First Lock-Up Period and continue until 12 months after the IPO Date.
The third lock-up period (the “Third Lock-Up Period”) will commence upon the expiration of the Second Lock-Up Period and continue until 18 months after the IPO Date. The fourth lock-up period (the “Fourth Lock-Up Period” and, together with the First Lock-Up Period, the Second Lock-Up Period and the Third Lock-Up Period, the “Lock-Up Period”) will commence upon the expiration of the Third Lock-Up Period and continue until 24 months after the IPO Date.9
Sometimes specific groups of employees are permitted to trade their shares after specific expiration dates. More often, however, the different periods release a specific percentage of shares.
During the Second Lock-Up Period, the undersigned will be permitted to sell up to twenty-five percent (25%) of the number of the Undersigned’s Shares that the undersigned beneficially owned as of immediately after the IPO Date.
Sometimes lockup agreements will specify a number of exceptions to the lockup period that allow some individuals subject to the agreement to sell or transfer shares under specific circumstances. Some common exceptions include the following:
- Transfers as gifts to charities
- Transfers because of divorce clauses
- Transfers because of wills
- Transfers to the company or its officers
These exceptions generally do not have a large effect on the open market.
To effectively negotiate lockup terms during the IPO process, companies must understand the purpose of those restrictions and the common exceptions to the traditional lockups. By implementing effective lockups, not only can the common investor be safeguarded, but the company can also be protected.
- Eli Ofek, Richardson Matthew. Stern School of Business, New York University. “The IPO Lock-Up Period: Implications for Market Efficiency And Downward Sloping Demand Curves.” Jan 2000.
- IHS Markit: IPO Lock-Up Agreements
- SEC Fast Answers: Initial Public Offerings: Lockup Agreements
- “In addition to the federal securities laws, every state has its own set of securities laws—commonly referred to as “Blue Sky Laws”—that are designed to protect investors against fraudulent sales practices and activities.” (SEC, “Blue Sky Laws.”)
- James C. Brau, Val E. Lambson, and Grant McQueen. “Lockups Revisited.” The Journal of Financial and Quantitative Analysis Vol. 40, No. 3 (Sep., 2005). pp. 519-530.
- Dan Rosenberg. “IPO Investing and Lockups: What to Know Ahead of DoorDash, Airbnb.” Ameritrade. 8 Dec 2020.
- Ramey Layne and Brenda Lenahan, Vinson & Elkins LLP. “Special Purpose Acquisition Companies: An Introduction.” Harvard Law School Forum on Corporate Governance. 6 July 2018.
- A seasoned equity offering or secondary offering is any issuance of new or sale of closely held shares of a company that has already made an initial public offering. (Investopedia, “Secondary Offering.” 2021.)
- Lyft, Inc. 7 Aug 2019. Form 8-K. Item 8.01.
- Snowflake INC. 29 Dec 2020. Form 8-K. Item 8.01.
- JFrog Ltd. 23 Nov 2020. Form 8-K. Item 8.01.
- Albertsons Companies, Inc. 2020. Exhibit 4.3