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An initial public offering (IPO) marks a major milestone for any company going public. While it unlocks access to more capital for the business, it also means that the promoters and pre-IPO shareholders need to remain invested in the company for a certain period. This is known as the IPO lock-in period.
What is an Initial Public Offering?
When a privately held company decides to list itself on a public stock exchange and make its shares available for the average investor to purchase, it’s called an Initial Public Offering, or IPO.
An IPO marks a major milestone where a private company transforms into a public company. It’s the first time the company invites public investment by issuing shares through the stock market.
What is an IPO lock-in period?
An initial public offering (IPO) lock-in period refers to a clause enforced by market regulators that restricts promoters and pre-IPO shareholders from liquidating their shareholdings for a specified timeframe after the company gets listed on the stock exchange.
As per this IPO lock-in period for retail investors clause, the promoters and large investors cannot sell or divest the locked-in portion of their shares for a certain period, ranging from 180 days to 3 years, depending on the company’s jurisdiction. They must remain invested despite any volatility in the share price during the lock-in window.
The objective is to build investor trust and stop founders and early backers from cashing out in the early days after enjoying premium valuations. If they start dumping shares in the open market, it can adversely impact price discovery and erode retail investor wealth.
Moreover, mandatory lock-in safeguards against unwarranted speculative trading by influential shareholders that can needlessly inflate the stock price. It signifies their long-term commitment to value creation instead of short-term financial engineering.
By inspiring confidence in retail investors, regulators enforce a lock-in clause as a progressive governance practice to bring transparency and stability to public markets during a company’s initial trading days. This sets the right tone at the top for the company’s journey as a listed entity.
Why is there a lock-in period for IPOs?
The concept of enforcing promoters’ lock-in period for IPO serves some important objectives:
Safeguard retail investors’ interests
Retail investors put their trust and savings in IPO stocks. Mandatory lock-in protects their interests against excessive speculative trading by large shareholders. It prevents share price manipulation if founders start cashing out in the early days through huge secondary sales.
Promote long-term thinking
Lock-in clauses disincentivise promoters and early investors from short-term financial engineering to realise quick gains. Instead, it aligns them with longer-term value creation to unlock wealth. They remain invested in steering the company towards sustainable growth over the coming years.
Stabilise share price discovery
IPO lock-ins curb unwarranted secondary transactions by influential shareholders. This provides stability and increases price discovery efficiency in the initial trading days without excessive volatility.
Establish good governance practices
By inspiring trust among public investors, IPO lock-in sets the right tone for corporate governance practices as a listed firm. It signifies the commitment of influential promoters beyond just raising capital.
In essence, lock-in clauses in IPOs strike the right balance between capital market stability and rewarding risk-taking by investors willing to back a longer-term growth story.
How does an IPO lock-in period work?
The following key rules govern the functioning of an IPO lock-in period:
- Capital market regulations pre-specify the lock-in timeframe, ranging from 180 days to 3 years when a company files its IPO offer document.
- Only a certain percentage of overall promoter/investor shareholding is subject to the lock-in clause. They can sell the remaining portion.
- The lock-in countdown starts from the date of final share allotment to eligible IPO applicants after the public issue closes successfully.
- During the lock-in window, promoters can transfer shares to other promoter entities, or investor shares can be transferred to another investor. But the shares still remain locked in with the new holder for the remainder of the timeframe.
- Regulators permit the pledging of locked-in shares only for margin financing needs subject to a limit. However, they do not allow invoked shares sold in the open market during the first year of listing.
- Company secretaries keep records and ensure compliance with lock-in clauses. The registrar follows up near expiry to check the status and confirm if a release is required.
- Any breach of lock-in attracts heavy penalties from SEBI, the capital markets regulator. It can even ban entities from accessing capital markets to raise funds for a prolonged period.
What happens if Lock-in Norms are flouted?
The Securities and Exchange Board of India (SEBI) stipulates the lock-in guidelines to regulate Indian capital markets. SEBI rules make promoters or pre-IPO shareholders who breach the lock-in clause liable to face stringent penalties.
If any entity transfers locked-in pre-IPO shares or pledged shares are sold before the expiry of the pre-IPO lock-in period, then the penalties imposed could include:
- Monetary fines up to ₹10 crores.
- Restriction on accessing capital markets to raise funds for up to 10 years.
- Freezing of shareholder voting rights.
- Mandating promoters to reduce the post-IPO holding to a minimum threshold.
Therefore, it is imperative for both promoters and investors to adhere to the applicable pre-IPO lock-in period norms, failing which exposes them to compliance risk.
IPO Lock-in period for promoters
Per Indian regulations, promoters must have a minimum lock-in of three years for a portion of their post-IPO shareholding. This rule applies to all the existing promoter shares, both pre-issue promoter shareholding and those allotted through the IPO.
However, promoters can sell or transfer their locked-in shares to other promoters or promoter group entities during this period. The shares must remain locked in with the new owners for the remaining duration.
Additionally, up to 20% of the total promoter shares locked in can be pledged only if required to finance the issue’s objects. However, the lenders cannot sell them in case of default during the first year of listing.
Conclusion
The IPO lock-in clause requires promoters and pre-IPO investors to remain invested for 1-3 years post-listing. It signifies their long-term commitment and curbs excessive speculation, driving price instability in initial trading days. Although lock-ins have limitations, they promote governance and retail investor confidence, essential for balanced capital market growth.
FAQs
The lock-in requirements typically apply to promoters, promoter group entities as well as pre-IPO institutional investors.
Yes, promoters can sell shares to other promoter group entities during lock-in. The same applies to pre-IPO investors transferring to other investors. However, the shares remain locked in.
The countdown begins from the final share allotment date after the IPO’s retail and institutional investor portion closes successfully.
Yes, only up to 20% of locked-in promoter shares can be pledged in the 1st year. However, invoked shares cannot be sold back then.
SEBI can impose fines up to Rs.10 crores, bar entities from accessing capital markets, restrict voting rights, freeze promoter holding reduction, and initiate enquiries.