Lock-In Period in IPOs: What Investors Need to Know

Understanding the Lock-in-Period in IPOs

The term “lock-in period” is a familiar concept across various financial instruments such as Fixed Deposits, Insurance Policies, Public Provident Funds, and Equity Linked Savings Schemes. Similarly, this term applies to Initial Public Offerings (IPOs) where certain stakeholders, including promoters and anchor investors, are subject to restrictions on selling their shares for a predetermined duration. The Securities and Exchange Board of India (SEBI) has established specific guidelines regarding lock-in period for IPOs to ensure market stability and investor confidence.

Types of Lock-In Periods

Under SEBI regulations, there are several categories of lock-in periods applicable in the Indian stock market:

1. Anchor Investors: These are institutional investors who commit to buying shares in an IPO well before it is officially listed. As per SEBI guidelines, anchor investors are subject to a lock-in period of 90 days for 50% of the shares allotted to them from the date of allotment. The remaining 50% of their shares are locked in for 30 days. Previously, the lock-in period for anchor investors was only 30 days, but it has since been extended to provide more stability to the market.
2. Promoters: The lock-in period for promoters varies based on the proportion of shares they are allotted:
   • For allotments up to 20% of the post-issue paid-up capital, the lock-in period has been reduced to 18 months from the earlier requirement of 3 years.
   • For allotments exceeding 20% of the post-issue paid-up capital, the lock-in period is now 6 months, reduced from the previous 1 year.
3. Non-Promoters: Investors who are not part of the promoter group but participate in the IPO also face a lock-in period. This duration has been shortened to 6 months from the earlier 1 year.

Once the lock-in period expires for a particular class of investors, they are free to sell their shares on the open market.

Purpose of the Lock-In Period

The lock-in period serves several crucial functions in the IPO market:

1. Market Stability: By preventing major investors from selling their shares immediately after the IPO, the lock-in period helps maintain stability in the stock’s price. Without such a restriction, there could be a rapid influx of shares into the market, leading to price volatility.
2. Investor Confidence: The lock-in period reassures other investors that significant shareholders are committed to the company’s future, thus reducing the likelihood of a sudden drop in share prices due to large-scale sell-offs.
3. Controlled Valuations: It helps control the valuation of IPOs by ensuring that initial investors, who often have a substantial influence on the stock’s performance, cannot exit the market too quickly, which might otherwise lead to inflated stock prices.

Drawbacks of the Lock-In Period

While the lock-in-period has its benefits, it also has potential downsides:

1. Market Perception: Lock-in-periods may create a false impression of the stock’s health and market sentiment. If major investors are restricted from selling their shares, it may obscure their true feelings about the company’s future prospects.
2. Post-Lock-In Price Drop: Historically, once the lock-in-period concludes, there is often a notable drop in the share price. This is because, after the lock-in-period ends, some investors might sell their shares to capitalize on any price gains achieved during the initial post-IPO period. The resulting oversupply of shares can lead to a decline in the stock price, which can negatively impact market sentiment.

Navigating the End of the Lock-In Period

For investors, managing the end of a lock-in-period involves a strategic approach:

1. Long-Term Focus: If you believe in the long-term potential of the company, focus on your investment goals and avoid being swayed by short-term price movements. The end of the lock-in-period can present buying opportunities if the stock price falls below its intrinsic value.
2. Trading Strategies: Traders may use various strategies to respond to the end of the lock-in-period:
   • Sell and Rebuy: Consider selling shares if the price drops significantly and buying them back at a lower price once it stabilizes.
   • Options Strategies: Employ bearish options strategies such as short calls or long puts if you anticipate a decline in the stock price. Conversely, if you expect the stock to recover, buying call options at reduced premiums might be advantageous.

Moving Forward

For retail investors, IPOs represent a significant opportunity to engage with a company from its early stages. Being part of a company’s journey right from the IPO can yield substantial returns for long-term investors. However, it’s crucial to stay informed about the company’s fundamentals and market trends.

If you’re interested in exploring upcoming IPOs, consider opening a Demat account with Angel One to start your investment journey. Our Knowledge Center offers valuable insights and information about stocks and investments to help you make informed decisions.

Understanding and strategically navigating the lock-in period can greatly enhance your investment experience, providing both opportunities and challenges in the dynamic world of stock markets.