By Tom Zanki
Law360 (September 17, 2021, 8:06 PM EDT) — More companies are relaxing lockup rules following their initial public offerings, making it easier for shareholders to sell stock without waiting six months after going public as changing market dynamics and competition from IPO alternatives begin to reshape conventional practices.
Three companies went public in the week of Sept. 13 with variations of early lockup expirations for certain shareholders, including running shoe company On Holding AG, drive-thru coffee retailer Dutch Bros. Inc. and identity software firm ForgeRock Inc., securities filings show.
They follow other companies that partly departed from traditional 180-day lockup rules in recent months, notably financial app Robinhood Markets Inc., mobile gaming company AppLovin Corp., cybersecurity software firm SentinelOne Inc. and technology-driven health insurer Oscar Health Inc.
A few splashy startups that went public in late 2020 like DoorDash Inc. and Airbnb deviated from the 180-day lockup script as well. Some capital markets lawyers say this increased willingness of market participants to experiment is another sign of a changing IPO market.
“I’ve never seen as many traditional IPOs having flexible lockup arrangements,” Foley & Lardner LLP partner Louis Lehot said. “It is for sure a big trend.”
Lockups bar existing stockholders from selling shares after their company goes public, typically for 180 days. No law requires a post-IPO lockup period, though six months has long been a firm market practice through arrangements negotiated between companies and IPO underwriters.
The idea behind lockups is that limiting the supply of shares tradable shortly after an IPO can contain price volatility and allow new investors to build holdings with less fear of a steep drop.
But this assumption has been tested in recent years, partly spurred by the growth of IPO alternatives such as direct listings that often don’t impose lockups. Eyewear retailer Warby Parker Inc. and consumer behavior analytics firm Amplitude Inc. plan to go public in the week of Sept. 29 through direct listings in which no shareholders will be subject to lockups.
In a direct listing, a company goes public by placing its shares on an exchange without hiring underwriters to sell new stock as in an IPO. Apart from saving on underwriting fees, one aspect of a direct listing that certain parties may find attractive is less stringent lockup provisions.
This can be especially true for employees at technology startups that are compensated with stock but haven’t been able to cash in because of restrictions that apply to private stock sales.
“There seems to be more desire (among companies) in getting liquidity, for employees in particular, a little earlier,” Simpson Thacher & Bartlett LLP partner Bill Brentani said.
Direct listings were considered an oddity when music streamer Spotify AG broke ranks and went public this way in 2018. But such listings have become less rare over the past three years, easing initial fears that loosening lockups and other IPO guardrails is too risky.
Fenwick & West LLP partner Ran Ben-Tzur said the experience of direct listings has accelerated conversations between companies and their underwriters over whether traditional lockup rules still make sense, adding that such dialogue had been underway for years.
“That discussion definitely came to a head with direct listings and more recently with SPACs,” Ben-Tzur said.
SPACs, or special purpose acquisition companies, represent another IPO alternative where deal makers have explored different lockup arrangements. SPACs are shells that raise money in an IPO in order to acquire a private company and take it public through a merger.
Lockup agreements in SPACs vary widely and are often longer than a traditional IPO, lasting up to a year after the merger, with different rules for various parties. But many lockups in SPAC acquisitions also allow early releases depending on the target company’s stock performance.
Several companies pursuing flexible lockups with traditional IPOs are also tying early releases to hitting stock price targets, which can be more achievable now given the hot IPO market.
ForgeRock, which went public on Thursday, contains a provision in its lockup that allows for limited early releases if shares rise 25% above their IPO price for a period after its next quarterly earnings release.
Conditioning early releases to rising stock prices is intended to manage fears that lockup expirations will result in shares flooding the market and hammer a company’s stock. ForgeRock CFO John Fernandez also said strong interest in new offerings by security-related software businesses, which have gone public in droves since the coronavirus pandemic, is a tailwind that helps put companies in a stronger position to negotiate flexible lockups with underwriters.
“The demand is so strong that the 180-day lockup is kind of an old thing of the past,” Fernandez told Law360 in an interview. “It’s not actually required.”
Fernandez added that he expects performance-based lockup releases will become “more widely acceptable, especially for high-demand software IPOs in the market today.” ForgeRock shares soared 46% on the first day, although stock prices can swing in the first few months after an IPO.
For now, there doesn’t appear to be a consensus as to how lockups should be relaxed as companies are exploring different avenues, some tied to stock performance and some not.
Companies offering relaxed lockups in traditional IPOs also tend to provide partial releases in stages rather than all at once. Some have offered lockup relief in small amounts to employees on the first day of trading, or after a quarterly earnings report that occurs months after an IPO.
Timelines for lockup expiration can also vary depending on whether the shareholder is an employee, venture capital firm, or a company executive or director.
“Bit by bit, it’s being chipped away,” Brentani said of lockup expirations. “But it’s also bespoke depending on the circumstances of the particular company and the investor base.”
Robinhood structured the early release of its lockup to happen in phases, allowing employees to sell 15% of their holdings on day one and another 15% three months later. The tiered approach is intended to prevent single-day stock plunges by limiting the amount of shares released.
Yet even as more companies experiment with lockups, the 180-day standard remains common in most IPOs across all sectors. Data provider Dealogic says the average lockup expiration in 2021 so far has occurred 186.6 days after an IPO, nearly identical with last year’s average.
Lehot of Foley & Lardner said he expects companies will continue exploring ways to ease lockup arrangements, noting that market performance will determine the success of these plans. In the case of AppLovin, certain shares for employees were released in August, about four months after the company’s IPO. The company’s stock fell to around $55 a share in mid-August but have since rebounded to about $72, above its first-day closing price of $65.20 when AppLovin went public in April.
As results from more early lockup expirations come in, market participants expect to have a better idea about whether shorter agreements work. Lehot said AppLovin’s example could argue in favor of the idea that early lockups don’t necessarily negatively impact trading.
“Whether the trend survives is totally dependent on whether the companies that have these mechanisms built in perform well in the aftermarket,” Lehot said. “I don’t think lockups will go away, but I do think they will continue to be tied to aftermarket trading performance of a company.”
–Editing by Orlando Lorenzo and Emily Kokoll.