BAJAJ BROKING
October 18, 2023
6 mins read
A business goes public by selling its shares to investors through an Initial Public Offering (IPO). The selling price of these shares is decided through the book-building process. Companies hire investment banks, which are known as book-running lead managers, to guide them through the process of IPO.
Understanding the drawbacks of the lock-in period
The lockin period for IPO has several disadvantages that investors should consider:
Misleading impression of stock demand: During the IPO locking period, investors are unable to sell their shares, which can create a misleading perception of demand and accessibility in the market.
Decline in stock price: Once the lockin period for IPO ends, a sudden rush of selling can occur as investors try to capitalise on gains. This oversupply may lead to a decline in stock prices, reducing overall value.
Limited liquidity: Investors are unable to access their funds during the anchor lock in period, which restricts their ability to meet financial needs or pursue other investment opportunities.
Risk of market volatility: The combination of these factors can lead to increased volatility in stock prices once the lock-in period concludes, impacting overall market stability.
When companies along with their underwriters decide on an IPO launch date, they may allocate a pre-IPO investment for certain investors. Such investments come with a lock-in period that prevents investors from cashing out on their investments.
Now, let’s learn about the meaning of lock-in period of IPOs and their function.
When a company goes public through an IPO, certain investors are restricted from selling their shares for a specific time, called the lock-in period. This period typically lasts six months but can extend up to a year, depending on the investor category and regulatory guidelines. The lock-in period aims to stabilize stock prices and reduce the risk of large-scale sell-offs immediately after the IPO listing. It ensures that major investors, especially promoters and anchor investors, hold their shares for a set duration, contributing to the long-term growth of the company.
The lock in period for an IPO is usually set at six months. However, it can be extended to 1 year. During this period an investor is not allowed to sell their shares.
The purpose of a lock in period is to stabilise a company’s share price before its investors can cash out. This will help the company attract investors with long-term goals who want to be a part of the company’s growth, unlike short-term investors who are just looking for a profit.
Lock-in period applies only to promoters and anchor investors who invest in shares ahead of the IPO launch date.
The lock-in period in an IPO is crucial to ensuring market stability and preventing drastic fluctuations in share prices after listing. It protects the company from the risks of immediate sell-offs by large shareholders. This period reassures other investors about the company's prospects, as major investors, including promoters and anchor investors, demonstrate their commitment by holding their shares for a specific time. Furthermore, the lock-in period helps create a sense of trust among retail investors, ensuring that large institutional investors do not immediately exit their positions to book profits after the stock's listing.
Despite its benefits, the lock-in period has some downsides. One significant drawback is that it can create a false sense of demand for the stock during the lock-in period. Retail investors may assume the stock's demand is stable when, in reality, large shareholders are simply unable to sell their shares. Once the lock-in period expires, these investors may exit their positions all at once, leading to a sharp drop in stock prices. This oversupply can drive down the share value, especially if there is no significant demand to absorb the large volume of shares being sold. Retail investors are often caught off-guard by this sudden downturn. Additionally, the restriction during the lock-in period can prevent investors from cashing out their investments even if the market conditions change, leading to a potential opportunity cost for them.
As the lock-in period comes to an end, investors must be prepared for potential market volatility. A large number of shares may enter the market simultaneously, resulting in fluctuations in the stock price. It is crucial to stay updated on the company's performance and market conditions during this time. Investors should avoid making decisions based solely on short-term price movements and instead focus on the company’s long-term fundamentals. For those holding shares that were part of the lock-in period, it may be wise to assess whether to continue holding the stock based on the company’s future growth prospects or to sell, depending on market sentiment and personal financial goals.
During the lock-in period, anchor investors cannot sell their stocks. This time allows a company to establish itself in the share market immediately following an IPO.
Stock prices can be quite volatile during this period. That is why it helps to have anchor investors, who are large institutional investors required to invest at least Rs. 10 crore in an IPO. Anchor investors are not allowed to sell their shares and have to wait till the expiry of the lock in period, which stabilises share prices.
Once this period is over, the shares become more liquid and can be traded freely on the stock exchange. Its price can fall or go up during this time depending on market conditions.
SEBI has some guidelines regarding the lock-in period in IPO. There are three types of lock-in periods:
Once these lock-in periods expire, investors can sell their respective part of shares.
Lock-in period in an IPO is believed to be beneficial for both investors as well the company launching an IPO. SEBI has come up with this guideline to prevent anchor investors from cashing out their shares the moment share prices go up.
This will help the company to gain some stability as well as attract other major investors. For the existing investors, it will help them gain confidence in their investments.
Additional Read: Upcoming IPO in December 2023
During the lock-in period, major investors are not allowed to sell their shares even if they want to. This can create a false impression regarding the stock’s demand in the market. Whether the anchor investors want to sell their shares or have confidence in their investments remains unclear to retail investors.
Another drawback is that the stock price could fall sharply once this lock in period is over. This happens when large investors sell off their shares at the same time to book profits. As the number of shares in the market increases, their values drop due to oversupply.
A bearish event occurs for the stock as potential investors take a step back seeing shareholders exit their positions the moment the lock in period is over.
Read also: How to Invest in an IPO Online
The lock-in period of an IPO has both its advantages and drawbacks. The investment stays safe during the lock in period, untouched by market fluctuations. However, you should always invest in an IPO based on the company’s fundamentals, and not by following the footsteps of anchor investors.
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If an investor sells his shares before the lock-in period is over, he may have to pay a penalty to the underwriter which is usually 2% of the share value. Added to that, he may also be subject to tax on any profit made from selling the shares.
Yes, you can sell your shares during the lock-in period but you will be liable to pay a penalty. This is usually a loss of 10% of share value. Also, you will have to find a buyer who can pay such a penalty.
Yes, stock prices can fall after their lock-in period expires. This happens if investors sell their shares right after the lock-in period. In this situation, there would be an oversupply of shares in the market and low demand resulting in lowered stock price.
The lock-in period does not restrict retail investors. It is only applicable to promoters, non-promoters, and anchor investors.
Once the lock-in period expires, investors are free to trade any shares that they had to hold mandatorily before. Hence, there can be a selling pressure. Depending on the price of shares, investors can either make a profit or a loss.
Stay informed about upcoming IPOs and their lock-in periods by downloading the Bajaj Broking app. Get exclusive access to detailed insights, analysis, and key dates related to IPO launches. Make well-informed investment decisions and stay ahead of the market trends with our user-friendly app.
The lock-in period restricts you from selling your shares for a specific duration. It stabilizes the stock price post-IPO, but once the period ends, share prices may fluctuate due to increased selling activity.
For tax-saving investments, such as ELSS funds, the typical lock-in period is three years. During this time, you cannot redeem or sell your investments.
No, you cannot sell or exit your investment before the lock-in period ends. This period is imposed to prevent early exits and stabilize stock prices or protect long-term investments.
The lock-in period benefits both the company and investors by reducing short-term volatility and ensuring long-term stability in stock prices, thereby attracting more long-term investors to the market.
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