The Initial Public Offering (IPO) is a significant milestone for a company going public. It provides the company with an opportunity to raise funds from the public while offering investors a chance to invest in potentially high-growth businesses. However, there is a key aspect of IPO that investors should be aware of—the lock-in period in an IPO. In this article, we will try to understand the lock-in period and its implications for promoters, anchor investors, employees of the company, and investors.
What is a Lock-In Period in an IPO?
The lock-in period is a pre-determined time duration during which certain key shareholders of the company are restricted from selling their shares in the market after the IPO. The purpose of this lock-in period is to ensure market stability after an IPO by avoiding a sudden influx of shares in the market, which could otherwise lead to a significant drop in prices of the shares.
Types of Stakeholders Subject to the Lock-In Period
1. Promoters
Promoters are those individuals or entities who are responsible for establishing and maintaining the company. SEBI mandates the following for promoters.
- Promoters must hold at least 20% of post-IPO shares, the lock-in period for these shares is 18 months (earlier it was 3 years).
- For the shares exceeding 20%, the lock-in period is 6 months ( reduced from 1 year).
Rationale: This rule ensures that the promoters have a vested interest in the company’s success and don’t liquidate their holdings prematurely.
2. Anchor Investors
Anchor investors are institutional investors who commit to buying a significant portion of shares in a company before its IPO.
In the case of Anchor investors, 50% of their allocation is subject to a lock-in period of 90 days.
3. Employees and Non-Promoters
Shares issued under preferential allotments now have a 6-month lock-in, reduced from 12.
What Are Preferential Allotments?
As the name “Preferential” suggests, it involves giving shares to a select group of individuals such as employees or external investors often at a discounted price. These shares are typically given to employees as part of employee stock options plans (ESOPs) or to strategic investors who contribute to the company’s growth.
Pre-IPO Investors
Venture Capitalists (VCs), Private Equity firms, or Angel Investors who invested in the company before an IPO could also have lock-in periods based on regulatory requirements and agreements.
Why Are Lock-in Periods Important?
The purpose of the lock-in period is to balance the interests of investors and companies.
- Protects retail investors: To prevent early investors from dumping (selling) stock immediately after listing.
- Stabilizes stock prices: To avoid excess volatility in the initial trading phase.
- Builds investor confidence: Encourages long-term investment from promoters and institutions.
Impact of End of Lock-in Periods on Stock Prices
The end of the Lock-in period may significantly influence stock prices:
- End of Lock-In: Share prices may see a dip as large shareholders offload their holdings.
Example: When the lock-in period ended for Zomato in 2022, the stock witnessed increased selling pressure.
How Should Investors Approach Lock-In Periods?
Research Company Fundamentals: Analyze whether the promoters and institutional investors have retained their shares post lock-in.
Monitor Price Movements: There could be a dip in the price of the company’s shares if large quantities of shares are sold.
Long-Term Perspective: The lock-in period could be an opportunity to buy shares if you as an investor believe in the company’s growth prospects as there might be a dip in prices.
Examples of Lock-In Periods and Their Impact
- Zomato (2022): Zomato’s stock faced heavy selling pressure after the end of the lock-in period, leading to a significant dip in its share price. This event highlighted the importance of keeping track of the lock-in period expiry dates
- Paytm (2023): Similarly, Paytm saw significant volatility when its lock-in period ended, as some institutional investors decided to exit.
- Nykaa (2022): Nykaa however saw a more stable transition after its lock-in period, as key investors chose to hold their shares, this reflected confidence in the company’s long-term growth prospects.
Conclusion
The lock-in period plays a very important role in protecting the interests of retail investors and creating market stability. By understanding the lock-in period, its impact, and from previous examples of IPOs with lock-in periods an investor can make an informed decision. As an investor, invest in an IPO only after thorough research and a clear strategy to maximize returns and minimize risks.
FAQs
1. What is the lock-in period of an IPO?
A lock-in period is a specific time duration after an IPO during which certain key shareholders of the company like promoters, anchor investors, or employees are restricted from selling their shares. The purpose of the lock-in period is to stabilize the market and prevent a sudden influx of shares.
2. What is the purpose of the lock-in period for IPOs?
The purpose of the lock-in period is for the following three reasons.
- To protect retail investors by preventing large-scale dumping of shares.
- Stabilize stock prices during the initial days after the company is listed on the exchanges.
- To encourage long-term commitment from promoters and early investors.
3. Who is subject to the lock-in period in an IPO?
Promoters:
Promoters must hold at least 20% of post-IPO shares, the lock-in period for these shares is 18 months (earlier it was 3 years).
For the shares exceeding 20%, the lock-in period is 6 months ( reduced from 1 year)
Anchor Investors
50% of their allocation is subject to a lock-in period of 90 days
Employees and Non-Promoters: For shares issued under preferential allotment the lock-in period is 6 months.
4. How can the lock-in period impact stock prices?
After the end of the lock-in period, the large shareholders might sell the holdings, which might result in a dip in share prices due to the increased supply of shares in the market.
5. What are preferential allotments?
Preferential allotment includes issuing shares to select individuals or groups, such as employees or strategic investors often at a discounted price.
6. How should investors approach the lock-in period?
Research company fundamentals: Check whether the promoters and institutional investors retain their shares after the lock-in period
Monitor price movements: Check for potential dip in prices after the lock-in period.
Adopt a long-term perspective: If you believe in the company’s long–term growth prospects, consider buying during the dip in prices.
7. What happens when the lock-in period ends?
After the end of the lock-in period, the shareholders are free to sell their shares. This might lead to increased selling pressure and temporary price volatility.
Happy IPO Investing!
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