An IPO lockup period is an often overlooked caveat of initial public offerings. In fact, this stipulation is in place to protect everyday investors like you and me. It also serves as a notice, or caution, for insiders to a specific IPO. Therefore, let’s take a closer look at a lockup period, what it means and how it works.

IPO Lockup Period Breakdown

An IPO lockup period is a period of time after a company has gone public in which major shareholders are prohibited from selling shares. In most cases, a lockup period will last anywhere from 90 to 180 days. Moreover, this stipulation typically applies to company insiders such as founders, owners, managers and employees. It can also include early-stage investors such as venture capitalists in some cases.

But why is this important? For starters, it prevents insiders from overloading the market with massive amounts of shares. This alone could cause the stock to plummet quickly.

When a company IPOs, it usually offers around 15-20% of its outstanding shares. The rest are owned by insiders. This is why you don’t want insiders flooding the market with tons of shares. It will cause the stock to drop.

Furthermore, an IPO lockup period is not mandated by the Securities and Exchange Commission (SEC). Or any regulatory body for that matter. It’s actually self-imposed by the company going public or required by an underwriter of the IPO. However, you can find information about a company’s lockup period in its SEC S-1 filing and any changes in subsequent filings.

In general, the goal is to keep the stock price going up after its debut. And once the lockup period ends, stock volume typically increases by 40% and the share price  drops by 1-3% on average, according to research by the Stern School of Business at New York University.

Pros and Cons of Lockup Periods

First and foremost, IPO lockup periods are a preventative measure. The main benefit is that it helps stabilize a stock price. Investors in the market will naturally buy and sell shares once the IPO goes live. And over the first few weeks and months, the stock price will balance out due to supply and demand.

A lockup period prevents selling pressure and promotes stability. But once the period ends, traders often short-sell the stock or use option contracts as a hedge against their long positions in the company.

As you can see, investors will sell off shares in anticipation of an IPO lockup period expiring. And in some cases, the sell-off is so dramatic that it can cause a short-squeeze. A short-squeeze happens when investors bet against a stock and the share price goes up instead. These short sellers are expecting the price to drop. Instead, the share price rises unexpectedly and causes the short sellers to exit their positions and cut their losses. This is something you must consider when investing in IPOs.

Investing in IPOs

The IPO process is so detailed that even the most experienced investors have to stay on top of their research. And it’s important that you do the same. For the latest IPO updates and stock analysis, consider signing up for one of the best investment newsletters. These investing guru’s will help you better understand the market and provide you with tips on how to enhance your portfolio.

Financial literacy can help you become a better investor. The more you know the better. And that is why many investors are turning to newsletters to keep their mind fresh. You now have a better understanding of an IPO lockup period. But don’t stop there. Continue learning more about the stock market and it will help you make better investment decisions in the long run.