Key takeaways
Lock-up periods block some shareholders from selling their shares for a certain period after an IPO.
Allowing employees to sell stock too early after an IPO can affect public perception of the company and hurt stock prices.
Lock-up periods can help stabilize stock prices, reward some investors, and prevent the market from getting flooded with too many sales.
Timing is everything
The moment of the big IPO day is approaching — you have worked hard for this moment. Maybe you have even checked out our Equity Outcome Simulator, and the math is mathin’ as the kids say on TikTok. Congratulations! 👏
However, as awesome as it will be to see your company's name in bright lights on the NASDAQ, remember that you may have to wait for another 90 or 180 days before selling your shares because of a lock-up period.
What is a lock-up period?
Lock-up periods are a set amount of time in which certain shareholders can’t sell or redeem their shares. These lock-up periods help keep things consistent at the company by ensuring that the company leadership remains intact during the time around the IPO and helps the business keeps running smoothly without a lot of sudden churn.
It’s common to have a lock-up period that lasts 90 or 180 days after a traditional IPO. During this lock-up period, the company’s employees won’t be allowed to sell their shares unless an early release enables them to cash out a small number of their shares. (Recent tech IPOs allowed employees to sell between 15% and 25% of their shares before the end of the lock-up period, according to TechCrunch.
Lock-up periods serve a few practical purposes, including:
Helping stabilize the stock price after it enters the market
Preventing the market from getting too flooded with sales
How does a lock-up period work?
When a company gives you stock options or shares as part of your equity compensation package, a percentage of company ownership belongs to you and your fellow employees. And since your strike price is likely much lower than the IPO price, there’s a chance to earn a healthy profit by selling your shares post-IPO.
However, this is where both optics and economics come into play. If all the employees dumped their shares onto the public market on the IPO it would a) appear the company is not worth investing in and b) flood the market and cause a drop in share price.
To help avoid some of the problems that can arise by employees selling stock too soon after an IPO, the investment banks that underwrite the IPO may mandate a lock-up period to limit sales. Even so, price declines are expected after the lock-up ends — but the question is, by how much?
For example, Robinhood had its IPO on July 30, 2021, with an opening price of $35. The lock-up period for employees and some investors ended on Dec. 1, 2021, and the price dropped 8% that week. A more dramatic decline happened when Uber’s lockup period ended in 2019, and its shares fell to 43% below their IPO price.
When should you exercise when there will be a lock-up period?
If you are playing the long game on your equity, you may want to exercise your stock options at least six months before the IPO to get the clock running to qualify your shares for long-term capital gains. To qualify as long-term capital gains, you need to have at least one year between when you exercise your stock options and when you sell your shares.
👉 Learn more about capital gains taxes and your stock options and selling your shares.
What if it’s a direct listing or a SPAC?
If a company chooses to go public via a direct listing, there are no new shares are created and there’s no underwriting for the offering. There won’t be a lock-up period, and employees can sell their shares immediately.
For example, when Spotify went public in 2018 they did a direct listing, with their IPO shares priced at $135 per share and the company’s shares continued to trade in that range. In fact, one of the company’s stated reasons for even doing a direct listing IPO was not to raise capital but to allow employees and investors to get some liquidity from their shares. And contrary to some expectations, there was not a flood of shares on the market after IPO.
Suppose a company chooses to go public under a special-purpose acquisition company (SPAC). In that case, the lock-up period could be longer than a traditional IPO, and employees and some investors might have to wait up to a year before selling.
Your next steps
First, patience and planning will be your friends. You cannot control the prices and vicissitudes of the IPO market. If you are looking to sell your shares after a lock-up, you may want to consult with an accountant or financial planner to make a plan. That could mean selling all at once after the lock-up period ends, or selling on a schedule over a period of time.
Nevertheless, remember that it all started with exercising. You can’t exit without exercising!
👉 Are you ready to exercise? Here’s how Vested works to provide option funding.
This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for investment, tax, legal, accounting, or other professional advice. Vested does not provide investment, tax, legal, accounting, or other professional advice. You should consult your own investment, tax, legal, accounting, or other professional advisors before engaging in any transaction or equity decision.