Are IPO Lockup Periods Negotiable? Maybe.

There are a few things in life that are inevitable: death, taxes, and, I thought, lockup periods after an IPO. But it turns out that lockup periods might be negotiable.

What Is a Lockup Period?

Before I explain what a lockup period is, let’s review how initial public offerings work. When companies go public through an initial public offering, they engage an underwriter (or several) to take them public. Rather than selling stock directly to the public, the stock that the company is issuing in the IPO is sold to the underwriters, who then resell it to other investors. One way that underwriters make a profit is by selling the stock to investors at a higher price than they pay the company for it. At the same time, the company is able to sell a lot of stock all at once, usually at a guaranteed price, so this arrangement is often a win for both the company and the underwriters.

Underwriters generally require that all officers, directors, and employees that hold company stock agree not to sell their stock for a period of time after the IPO, usually six months (180 days). If all of these folks sell their stock the minute the IPO is effective, that will potentially flood the market with shares and drive down the price of the stock. This isn’t good for anyone—not the underwriters; not the officers, directors, and employees; and not the investors who buy stock in the IPO.

In addition, the underwriters have a responsibility to establish a market for the company’s stock once the IPO is complete. If officers, directors, and employees are continuing to sell their pre-IPO stock in the period after the IPO, this can interfere with the underwriters’ efforts to establish a market for the stock. Six months has emerged as the standard for the length of time underwriters should have to establish a market before officers, directors, and employees are allowed to sell their stock holdings.

What’s Changed?

Recently, some companies have skipped an IPO and instead just listed their stock on an exchange, without the assistance of an underwriter—this is called a “direct listing.” The primary advantage of an IPO is that it raises a lot of capital for the company through the issuance of new shares of stock. Companies that don’t need to raise capital aren’t likely to be interested in an IPO but might still be interested in having their shares publicly traded. A direct listing accomplishes the publicly traded goal without the hassle of an IPO. Slack and Spotify are two companies that skipped an IPO for a direct listing.

An underwriter isn’t needed for a direct listing. No underwriter means no lockup. Indeed, one reason a company might directly list its stock might be to allow employees, et. al., to sell their stock. When stock is a significant component of pay for private companies, the companies will eventually be pressured to give employees an opportunity to liquidate their investment.

Direct Listings Put Pressure on Underwriters to be More Flexible

The increasing prevalence of direct listings (companies that skip an IPO and simply list their stock directly on an exchange) and other alternatives to traditional IPOs has pressured underwriters to offer more flexible terms with respect to lockup agreements. Fenwick & West surveyed more than 80 US tech companies that have had IPOs since the start of 2017 (“Terms of IPO Lockup Agreements for Technology Companies Shift as Direct Listings and SPACs Gain Traction,” Aug. 31) and found that some now have early-release provisions. Below is a summary of their findings.

Six-Months Still the Norm: The standard 180-day lockup period doesn’t seem to be going away any time soon. Nearly 100% of respondents reported implementing a 180-day lockup period after their IPO.

Early Release for Blackout Periods: Sometimes companies are in a blackout period when their lockup expires. When this occurred in the past, the trading blackout further delayed when employees could sell their stock. But Fenwick’s survey found that 14% of respondents’ lockup periods provided for early release (e.g., ten days before the start of the blackout) if their lockup was scheduled to end during a blackout. Over 70% of companies with this release provision went public in 2019, suggesting it is a newly emerging trend.

Price-Based Release: Fenwick also found a few companies with price-based early release provisions, albeit significantly fewer than those with an early release for blackout periods. With a price-based release, employees are allowed to sell a portion of the locked-up shares early if specified price targets are achieved (most commonly a 33% increase from the IPO price).  

It will be interesting to see if these or other early-release provisions become more standard for lockup periods.