What Is IPO Lock-in Period? Rules, Categories & Key Takeaways

Let’s say, you are playing a game of cricket and are at the non-striker’s end. The bowler runs to bowl, and before he does, you leave your crease. The bowler cautions you. However, you try it again only to see your stumps broken. The umpire gives you out, and you walk back to the pavilion. Disappointing, but the rules are clear. The non-striker cannot leave the crease unless the bowler has released the ball to gain an unfair advantage. He must stay in his crease.

In the IPO world, this cricketing rule loosely translates into the lock-in period. The difference is that here there is a category of investors who cannot immediately sell their shares right after the IPO. In other words, they must hold onto their shares for a certain time before selling. This time period is known as the IPO lock-in period. So, what exactly is this period, and why is it in place? For which category of investors does the period apply? Read on to find out.

What Is The Lock-in Period In An IPO?

The IPO lock-in period is the period during which certain investors, particularly large ones, are not permitted to sell their shares. This time can range from a few months to a year. The goal of the IPO lock-up period is simple. It is to prevent large investors from exiting and staying committed. If large investors sell their shares immediately, it can affect the stock price. It can also negatively affect investor confidence.

Why Does Lock-in Period Matter In IPOs?

There are multiple reasons for the IPO lock-in period. The IPO lock-in period helps:

Maintain Market Stability

When a company gets listed, its share price is sensitive. If large investors start selling their shares immediately, share prices can fall. The lock-in period helps prices to settle in the initial months. In the process, it helps maintain market stability.

Prevents Large-Scale Sell-Offs

Some investors, like promoters and shareholders, often get a lot of shares. If all of them sell them after the IPO, there could be a lot of selling. When that happens, the stock price can fall sharply. The IPO lock-in period helps prevent this kind of sudden sell-off and keeps the market stable.

Helps Reduce Market Manipulation

Without the lock-in period for IPO, insiders can misuse their position. They can artificially boost stock prices before the IPO. Post listing, they can sell shares at a premium. The lock-in period reduces the chances of market manipulation.

Aids Long-Term Value Creation

The IPO lock-in period encourages long-term thinking. As large investors cannot immediately sell shares, the focus is more on building the company's value. This can help the company grow steadily and boost trust among the public.

Who Is Subject To The Lock-in Period?

Note that when a company goes public, several categories of investors bid for allotment. The various categories of investors subject to the lock-in period are as follows:

Promoters / Founders

Promoters and founders are vital stakeholders. They are responsible for smooth company operations. Hence, their holdings are subject to strict lock-ins. They are subject to a lock-in of 18 months.

Pre-IPO Investors

These investors include private equity and venture capital funds, as well as other strategic investors. They invest in the company before it goes public. Their shares are locked in generally for 6 months.

Anchor Investors

Anchor investors include asset management companies, insurance companies and sovereign funds. They invest one day before the IPO opens for bidding. There is a two-tier lock-in period for anchor investors (see table):

Retail Investors

There is no lock-in for retail investors. Once they receive their allotment, they are free to sell in the open market. In other words, they can buy and sell shares like normal stocks upon listing.

What Happens After The Lock‑in Period Ends?

After the IPO lock-in period ends, restricted shareholders are free to sell their shares. As a result, the number of shares can increase significantly. If many of them decide to sell at the same time, it can create short-term pressure on the stock price. However, it may not necessarily lead to a price decline.

However, restricted shareholders may also choose to hold on to their investments if the company is performing well. They can choose to wait and sell their shares when the price is at its peak. As a retail investor, you can adopt a wait-and-watch approach after the lock-in period ends. If the company's prospects are good, a short-term price dip should not affect you much.

Advantages And Disadvantages Of IPO Lock-in Period

The IPO lock-in period has multiple advantages. That said, it has certain disadvantages too. These include:

Prevents Instability

Thanks to the lock-in period, markets tend to be stable. Sudden selling can create panic and drag markets down. If it happens, it can wipe out a chunk of investors’ wealth in no time.

Builds Long-term Trust

The IPO lock-in period helps build long-term trust. When a certain category of investors is not allowed to sell their shares, it protects the interests of retail investors. It also reduces speculation and chances of market manipulation.

Limits Liquidity

This is a disadvantage of the IPO lock-in period. With fewer shares available for trading, trading volume tends to be lower. This can limit liquidity. Limited liquidity can make it hard for investors to enter and exit markets.

Potential Post Lock-in Selling Pressure

After the lock-in period is over, shareholders who are not allowed to sell their shares can do so. If a lot of people decide to sell at the same time, there may be more supply than demand. This can make the price of shares go down.

Key Takeaways For Investors

The IPO lock-in period is vital to maintaining market stability and protecting the interests of retail investors. To know the applicable lock-in and other essential details, you can go through the company’s draft red herring prospectus. It has important information, like the company's finances, strengths, and risks, that helps you make smart choices.

Conclusion

IPOs are very important in India's growing economy. They help companies get money and grow. The lock-in period supports this process. It makes the IPO market more reliable for everyone.

Sources:

TOI
Livemint
SEBI