What Does IPO Lock Up Mean

IPO Lock up

Why do IPOs have a lock in period for large institutional investors. It is to ensure skin in the game. After all large institutions cannot act like retail investors and thin with their feet. In an initial public offer or IPO, some portion of the shares belonging to the promoters or to the early institutional investors tend to be locked in. The IPO share price normally gets a boost when large investors are under lock-in as it prevents large scale supply of shares in the market.

Investors in IPOs would be quite familiar with the term called IPO lock-in period which is used to denote a period when certain investors in the IPO cannot sell. We will look at this aspect in detail when we look at the different forms of the IPO lock in period.  This refers to the period during which the IPO shares are locked in and cannot be sold by the investors.

Through this section, let us first understand what is IPO in share market and the concept of IPO as well as the concept of lock-in. Then let us understand why some portion of IPO shares are locked and what are the merits and demerits of such a move. Let us begin by understanding what is IPO in share market and what the concept of IPO share price implies.

Let us focus here on what is the IPO share price and how the concept of lock-in work in practice. We will look at two distinct phases of the IPO lock-in i.e. prior to April 2022 and post April 2022, when the new lock-in rules became applicable on IPOs. These changes are vast and are intended by SEBI to protect the interests of the investors. As a concept, the lock-in period can be defined as the tenure during which withdrawal is not allowed. In the case of IPO, the promoters and anchor investors must adhere to the minimum lock-in requirement as outlined under SEBI guidelines.

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Starting with understanding what an IPO is all about?

An IPO or represents the process by which a private unlisted company goes public. Remember, private limited companies cannot go public. They first need to convert themselves into a public limited company before going for an IPO. The IPO is essential to get the stock listed on the stock exchanges and permit popular trading in the stock markets or the secondary markets as we know it. It can either be in the form of a fresh issue or an offer for sale or the OFS as it is popularly known. The fresh issue, actually raises fresh capital with funds infusion coming into the company. Fresh issue results in fresh issue of shares and hence it is EPS dilutive. That means, the profits get distributed across more investors so the per capita EPS for shareholder goes down.

In an offer for sale (OFS), the promoters or the early investors (like PE investors, FPIs, Venture Capital firms or even family offices / HNIs) offer their shares as part of the IPO. In an OFS, there is only change of ownership and an expansion of the public float to enable listing of the stock. OFS does not result in fresh infusion of funds into the company and as a result of that, the OFS is not EPS dilutive, since the overall outstanding number of shares do not change. That should be sufficient to grasp the basics of an IPO for the time being and this strong base allows to now move on to the concept of lock-in period in IPOs.

Regulation Phase 1 – How IPO lock-in was applied prior to April 2022

Here were some of the salient features of the IPO lock-in period rules prior to April 2022 and that had bene the norm for a very long time. April 2022 represents the month when the new IPO lock-in rules of SEBI became effective. The new lock-in rules insist on more skin in the game so that the large institutional investors cannot shirk their responsibility of having their skin in the game. Here are the key highlights of pre-April 2022 regulation on IPOs.

• When a company goes public, the identified promoter group has to maintain a minimum contribution of not less than 20% of post-issue capital. Such contribution from the promoters is subject to lock-in for a period of 3 years. What is the start of the lock-in period? The lock-in period for the IPO begins from the date of allotment of the IPO and the calculation of 3 years commences from the date of allotment.
• However, there was one relaxation offered to the promoters lock-in prior to April 2022. For instance, if promoter contribution in the IPO was more than the minimum threshold of 20% requirement, in that case the excess portion would be locked-in for a period of just 1 year from the date of allotment and not for 3 years. So this 3 year lock in applied only in the case of the 20% holding.
• Apart from the promoters, the concept of lock-in will also extend to other early investors like institutions, HNIs and family offices and in such cases, the lock-in period would be 1 year from the date of allotment. This will also include any pre-issue capital held by the non-promoter early investors ahead of the IPO and includes any strategic pre-IPO allotment of shares done by the company.
• For anchor investors, in the pre-April 2022 scenario, the lock in period applicable was 30 days from the date of allotment of the shares. The full 100% anchor allocation of shares was subjected to a mandatory uniform lock-in period of 30 days till April 2022.

However, the picture has been totally different post April 2022.

Regulation Phase 2 – How IPO lock-in was applied after April 2022

As per a SEBI circular on modified lock-in period for promoters, anchors and other early investors, there were several changes proposed by the regulator. An important change was that in the light of the rise in digital IPOs, SEBI decided to replace promoters with “Controlling Shareholders” category. Another major change was to relax the lock-in requirements for promoters to ensure better liquidity. In short, the regulator has looked to rationalize the IPO lock-in rules to a large extent. Here are the highlights.

• Effective April 2022, the lock-in period for promoter (controlling shareholders) holding up to 20% of IPO was halved from 36 months to 18 months. For residual holdings of promoters beyond 20% and for non-promoter holdings, lock-in period has again been halved from 12 months to 6 months.
• While promoters got some concessions, the anchor investors norms were tightened. The lock-in norms for anchor investors have been made more stringent to reduce post-IPO volatility. The extant anchor investor lock-in period of 30 days will apply to 50% of the portion allocated to anchor investors. For the remaining 50% portion, the lock-in period will be increased to 90 days from the allotment date.