The Keys to Lockups

Aug. 2 -- Nothing can help your stock more than having a bunch of big shareholders prohibited from selling their shares. But guess what can happen when that restriction is lifted?

Think Skylab.

In the months following an initial public offering, company employees, directors and venture capitalists are usually banned from selling their shares in the newly public company. These folks got stock before thecompany went public, typically much cheaper than the IPO price. This so-called lockup period typically lasts for 180 days but can be as short as 90 days and as long as 1,000 days or more.

A lockup doesn’t mean a stock doesn’t trade. It just means that certain holders aren’t allowed to sell during a specified period. The idea behind a lockup is to prevent a flood of new shares from entering the market right after the IPO. Limiting the supply or the number of shares trading can help keep the price of a new stock up.

That Magic MomentWhen a lockup period ends, which is referred to as the lockup expiration, insiders are free to sell their stock. The fear: They will unload their shares, inundate the market and drive the stock price down.

The conventional thinking says a stock’s price will flatten or fall in the days and weeks before that date arrives — just on the perception that insiders will dump their stock when the selling restrictions are lifted. The stock will then come back in the days after the lockup expiration. Or, maybe it won’t.

Predicting when and how a lockup expiration will hurt a particular issue is just not that easy.

One 10-year study by two assistant professors at Penn State University found that the average stock fell about 2 percent in the week the lockup agreement expired. Another study by Thomson Financial, Investor Relations which looked at IPOs from the first half of 1999, found that these expirations had almost no effect.

It’s All About TimingThere’s no exact formula for playing IPO lockup expirations. The effect depends on the company, the market climate and how many shares might hit the market.