IPO Share Lock-up Expiration

IPO Lockup Expiration

Part of the IPO underwriting agreement covered in the prospectus is the "lock up period" which tends to be 180 days. Variations can and do occur due to "blackout" restrictions around earnings reports.

When a company comes public they offer a certain amount of shares. Once public this becomes the "float" and what trades in the market. Typically most of the shares offered are "primary" which means they are new shares sold by the company in exchange for cash. Sometimes there are "secondary" shares offered and these are from *existing* shareholders. Most existing shareholders do not sell in the IPO and are "locked up" until they are permitted to sell shares in the open market.

Often the release of these locked up shares can pressure a stock. For example let's take a look at Editas Medicine (EDIT) which came public on February 3, 2016. Going forward 180 days that would make their lock-up release date August 1, 2016 which is coming up.

The Lock-Up Expiration Impact

Here is the lock-up statement from the Editas prospectus:

Upon expiration of the 180-day lock-up period described below, and disregarding any restrictions due to vesting, approximately 28,122,234 shares of our common stock will be eligible for sale under Rule 144, including shares eligible for resale immediately upon the closing of this offering as described above. We cannot estimate the number of shares of our common stock that our existing stockholders will elect to sell under Rule 144.

To put that in perspective the company sold just over 6 million shares in their IPO and have a float of about 36 million shares. So an incremental 28M shares coming to the market can certainly put some pressure on price.

Another step in the process of understanding lock-up expiration impact is to look at the existing shareholders. Here is the table of ownership from the prospectus:

Screenshot 2016-07-20 12.42.34

As is typical for a VC-backed company most of the shares are owned by VC firms. VC firms all have different policies around how they handle their disposition of shares after a company is public but in general they aim to sell or distribute them. They are after all in the business of making and growing private investments, not public ones.

Organized Secondary Offerings

Sometimes a company and their bankers will jump in front of the scheduled expiration of the lock-up agreement an announce a secondary stock offering. Sometimes with a roadshow by the management team. This can help the shares coming out find new homes with large institutional investors. In some cases they add a few primary shares too in order to raise capital, especially if the share price has increased substantially from the IPO. If the company is smart they also will add a bank or two to the cover in order to expand their research coverage. It's dumb not to do it.

On announcement these transactions tend to send the stock down a few percentage points. It often recovers during and post the deal process. Generally speaking an organized transaction compresses the stock action (drop then recover) versus the slow bleeding that a general release of shares has on the market.

How we look at lock-up expiration

Every situation is unique in terms of the stock - how strong is the story? how much have the shares appreciated? are we in a "risk on" or a "risk off" market environment? Generally though the expiration of a lock-up is either 1) a chance to buy a leading new company at a discount or 2) a chance to short a weak or mediocre company before earlier investors rush for the exits. Because lock-up expiration can be a sliding window depending on quiet periods and blackout dates imposed by the company we tend to look at them two to four weeks out.

Sometimes shares find a level before lockup expiration and they may be less volatile around this period if all other things are equal. For example as the chart on EDIT demonstrates, the shares have been steady at $25 after the IPO hype and stock initiations are over.

Screenshot 2016-07-20 12.48.00

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We put some extra material together on lock-up expirations and the ending of IPO quiet periods that may be helpful to review.

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