Last Updated on December 4, 2023 by BFSLTeam BFSLTeam
A business goes public by selling its shares to investors through an Initial Public Offering (IPO). The selling price of these shares is decided through the book-building process. Companies hire investment banks, which are known as book-running lead managers, to guide them through the process of IPO.
When companies along with their underwriters decide on an IPO launch date, they may allocate a pre-IPO investment for certain investors. Such investments come with a lock-in period that prevents investors from cashing out on their investments.
Now, let’s learn about the meaning of lock-in period of IPOs and their function.
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What Is the Lock-In Period in IPOs?
The lock in period for an IPO is usually set at six months. However, it can be extended to 1 year. During this period an investor is not allowed to sell their shares.
The purpose of a lock in period is to stabilise a company’s share price before its investors can cash out. This will help the company attract investors with long-term goals who want to be a part of the company’s growth, unlike short-term investors who are just looking for a profit.
Lock-in period applies only to promoters and anchor investors who invest in shares ahead of the IPO launch date.
How Does the Lock-In Period for IPO Work?
During the lock-in period, anchor investors cannot sell their stocks. This time allows a company to establish itself in the share market immediately following an IPO.
Stock prices can be quite volatile during this period. That is why it helps to have anchor investors, who are large institutional investors required to invest at least Rs. 10 crore in an IPO. Anchor investors are not allowed to sell their shares and have to wait till the expiry of the lock in period, which stabilises share prices.
Once this period is over, the shares become more liquid and can be traded freely on the stock exchange. Its price can fall or go up during this time depending on market conditions.
What Are the Types of IPO Lock-In Periods?
SEBI has some guidelines regarding the lock-in period in IPO. There are three types of lock-in periods:
- Lock-in period for promoters has been reduced to 18 months for up to 20% of the post-issue paid-up capital. This used to be 3 years earlier. Lock-in requirement for allotment over 20% is further lowered to 6 months from 1 year.
- A lock-in period of 90 days is applicable for anchor investors on 50% of allotted shares from the date of allotment. For the remaining 50% of shares allotted, a lock-in duration of 30 days is applicable.
- For non-promoters, this lock-in period has been reduced to 6 months from 1 year.
Once these lock-in periods expire, investors can sell their respective part of shares.
What Is the Significance of a Lock-In Period in an IPO?
Lock-in period in an IPO is believed to be beneficial for both investors as well the company launching an IPO. SEBI has come up with this guideline to prevent anchor investors from cashing out their shares the moment share prices go up.
This will help the company to gain some stability as well as attract other major investors. For the existing investors, it will help them gain confidence in their investments.
Additional Read: Upcoming IPO in December 2023
Are There Any Drawbacks of the IPO Lock-In Period?
During the lock-in period, major investors are not allowed to sell their shares even if they want to. This can create a false impression regarding the stock’s demand in the market. Whether the anchor investors want to sell their shares or have confidence in their investments remains unclear to retail investors.
Another drawback is that the stock price could fall sharply once this lock in period is over. This happens when large investors sell off their shares at the same time to book profits. As the number of shares in the market increases, their values drop due to oversupply.
A bearish event occurs for the stock as potential investors take a step back seeing shareholders exit their positions the moment the lock in period is over.
Summary
The lock-in period of an IPO has both its advantages and drawbacks. The investment stays safe during the lock in period, untouched by market fluctuations. However, you should always invest in an IPO based on the company’s fundamentals, and not by following the footsteps of anchor investors.
Frequently Asked Questions
If an investor sells his shares before the lock-in period is over, he may have to pay a penalty to the underwriter which is usually 2% of the share value. Added to that, he may also be subject to tax on any profit made from selling the shares.
Yes, you can sell your shares during the lock-in period but you will be liable to pay a penalty. This is usually a loss of 10% of share value. Also, you will have to find a buyer who can pay such a penalty.
Yes, stock prices can fall after their lock-in period expires. This happens if investors sell their shares right after the lock-in period. In this situation, there would be an oversupply of shares in the market and low demand resulting in lowered stock price.
The lock-in period does not restrict retail investors. It is only applicable to promoters, non-promoters, and anchor investors.
Once the lock-in period expires, investors are free to trade any shares that they had to hold mandatorily before. Hence, there can be a selling pressure. Depending on the price of shares, investors can either make a profit or a loss.
