Page 126 - Initial Public Offering - An Introduction to IPO on Wall Street

Investing Considerations

Many investment professionals believe that investors should wait until the lock-up period ends
before making investments in newly listed companies. Although new stocks will only continue
to grow in some bull markets, the market is not always favorable to IPOs.

New stocks often experience a decline in price in less favorable markets as insiders offload
their shares after the lock-up period. Investors will then move in to buy shares of the relatively
new business at a discount.

When insiders have significant stakes in the business, the odds of getting a discount this way
increase. Additionally, waiting until the end of the lock-up period allows investors more time
to assess the performance of the stock. If it dropped out of the gate right away, then investing
in something else altogether may be a wise decision. If the stock looked good before the time
of lock-up ended, then it could still prove to be a worthwhile investment.

Options Strategies

The IPO lock-up period also has some significant ramifications in the options market. On the
day of the IPO, options are not accessible. However, they generally become accessible before
the end of the IPO lock-up duration for large and even midcap firms.

If investors are worried about a possible stock downturn after the expiration of the lock-up
period, they may be able to purchase protective puts. Depending on which way they anticipate
the stock price to go, speculators may choose to simply purchase puts or calls.
Example of Lock-up Period

Facebook probably provides us with the most noteworthy example of a lock-up period.
Following Facebook’s initial public offering on May 18, 2012, the lock-up stopped 268 million
shares from being sold during the business's first three months of public ownership.

The stock price of Facebook dropped to an all-time low of $19.69 per share on the day its first
lock-up period concluded. That is around 50% less than the share price of the business on the
day it went public.

It is important to note that Facebook implemented tighter-than-normal controls that prevented
the selling by mid-2013 of another 1.66 billion shares. After all the important things were
considered, Facebook's unusual lock-up policy released the shares of insiders on five separate
dates.
Key Takeaways

An IPO lock-up period is a statutory restriction that prohibits business insiders owning stock
from selling their stock for a specific duration before the business goes public. Such insiders
can include owners of companies, investors, workers, executives, and venture capitalists.

The goal of lockups is to prevent corporate insiders from abruptly divesting assets after a
business’s IPO. It helps to makes sure that a sudden influx of sales would not lower the stock
price.

The lock-up duration for newly issued public shares tends to control the stock's price as it
reaches the market. It can appear that the business is not worth the investment if corporate
insiders sell their stock in the business to the public, thereby making lock-ups critical.

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