What Is The Lock-In Period In An IPO?

Lock in periods in IPOs are there to ensure the best interests of the investors by preventing excess volatility in asset price, especially price drops, in the few months following the IPO release.

Why IPOs are good for you

IPOs are a great way for investors (both institutional and retail investors) to earn quick returns. This is because IPOs usually bring a new gush of capital to the company that increases the company’s liquidity. This in turn boosts the company’s operational capabilities, growth prospects and innovation – all of which eventually leads to an increase in the stock price.

Moreover, general perceptions regarding a new company with zero track record in the stock market is usually positive – hence the market tends to be bullish when it comes to IPOs, especially if there are no major flaws in the balance sheet of the company.

However, before you invest, it is important for you to research adequately about IPOs and related details such as IPO lock in period. Read on to know more about lock in period meaning in IPO are and how they affect market sentiments and stock prices.

Quick recap: What is an IPO?

An initial public offering (IPO) occurs when a fully privately held company opens up its shares to be traded on an exchange becomes a publicly traded company. IPOs are typically initiated to get new equity capital for companies, to cater to the existing goals of the companies. 

For each IPO, there are some key details that are associated with the IPO process, even beyond the IPO launch. The lock in period is one such detail that investors need to look out for. 

What is lock in period meaning in an IPO

We all are familiar with the term lock in period. It is widely used in the financial world i.e. lock in periods for Fixed Deposits, Insurance policies, Public Provident Fund, Equity Linked Savings Scheme etc. Similarly, promoters and anchor investors (i.e. major investors who buy shares much ahead of a proposed IPO) also have a lock in period for their investments before which they cannot sell their holdings. The stock markets regulatory body, SEBI has placed certain guidelines on lock in period for IPOs.

Types of lock in periods

As per SEBI guidelines, types of lock in periods in Indian stock market includes :

  1. lock in of 90 days on 50% of the shares allotted to the anchor investors from the date of allotment and a lock in of 30 days on the remaining 50% of the shares allotted to the anchor investors from the date of allotment. (Initially the lock in period for anchor investors was a mere 30 days but later has been extended to 90 days)
  2. For promoters, the lock in requirement for allotment up to 20% of the post issue paid-up capital has been reduced to 18 months from the earlier 3 years. The lock in requirement for allotment exceeding 20% of the post-issue paid-up capital is reduced to 6 months from the earlier 1 year.
  3. The lock in period for non-promoters has also been reduced to 6 months from 1 year.

Once a lock in period for a particular class of investor ends, those investors can then sell the shares they own in the company.

Why is lock in period needed in IPO

Many market experts believe that lock in periods are a necessary way to keep in check the lofty valuations companies have been coming up with their IPOs considering the fact that anchor investors could have an easy exit within a month of the stock listing. 

This move by SEBI is believed to provide more confidence for other investors because now, major investors cannot dump their shares the moment they attain some capital appreciation. This allows some stability in the price of the shares right after an IPO – thus the lock in period helps both investors and the company itself.

Downside of lock in period

lock in periods prevent major shareholders from exiting their holdings in the company. Therefore, it creates a false impression of the stock in the market – the fact that major investors may want to dump shares of a company that they do not hold much expectation from remains unclear to retail investors. 

Once the lock in period gets over, the price of the share often falls. This happens because after the end of the lock in period, some of the investors sell their shares to take advantage of the increased prices due to the post-IPO frenzy. As the investor leaves, there is an over supply of shares in the market, which results in the fall of the price of each share. Consequently, the market sentiment towards the stock also turns relatively bearish as potential retail investors are negatively affected by the fact that major investors are jumping ship and dumping the shares. Therefore, lock in periods ending is often considered to be a test of the market sentiments surrounding the company.

How to handle end of lock in period

As an investor, it is important to stay focused on the long term goal and not be  perturbed by lock in period closures, especially if you are confident of the company’s growth prospects and financial stability. However, you may take advantage of the fallen share price to buy some more shares of the company.

As a trader, you may take a call as per your instrument. You may sell shares and buy them back once the price drop has ended at a support level. You may also place bets in the options market through bearish strategies such as short call or long put in the short run among others. Or if you are confident that the price will soon recover, you may buy some cheap call options, taking advantage of the lower premiums due to bearish sentiments in the market.

Going Forward

As a retail investor IPOs could be a good entry point to dabble in the world of stock markets. The chance to be associated with a company and its brand right from the initial phases of stock listing could reap good returns for long term investors. To know more about the upcoming IPOs, open a Demat account today with Angel one and start your investment journey. Please check out our knowledge center to know more such interesting things about stocks and investments.