Traders work on the floor at the New York Stock Exchange.
Brendan McDermid | Reuters
Lock-up periods are expiring for this year’s IPO class, which analysts say could introduce a new layer of pressure for young companies.
Founders, employees and some early private investors who bought in before a company goes public are usually restricted from selling between 90 and 180 days. Uber, Pinterest, Slack and others are approaching that expiration date between mid October and the end of the year.
A flood of selling could weigh on already struggling IPOs, and dissuade other start-ups from entering public markets this year, according to analysts. It’s also a reason some in Silicon Valley are lobbying for direct listings, which don’t have the same selling restrictions.
“As lock-ups expire, some of that shortage of supply goes away,” said Nick Colas, co-founder of DataTrek Research. This flood of shares could put pressure on stock prices, he added.
Uber has struggled since its public debut with shares down roughly 35% since. The ride-hailing company is by far the biggest of the newly public companies with shares unlocking in the coming months. Private markets are often opaque and estimates vary — one by research firm “The Bear Traps Report” puts the total Uber shares unlocking closer to 763 million, worth $22 billion. The same firm says roughly $31 billion worth of public company shares are unlocking from now until the end of this year.
Slack is also trading slightly below its IPO price. Others have fared better though: video-conferencing start-up Zoom is trading at more than double its IPO price, while Beyond Meat has more than quadrupled in value. Pinterest is up more than 30% since its IPO.
If founders decide to sell around the lock-up date ending, shares flood the market, which DataTrek’s Nick Colas said can be an added drag on stock prices. Colas said early private investors are likely to sell regardless of an IPO’s performance so far this year.
“Their job is to get the company to the private markets, then to sell,” he said. “Venture capitalists are going to sell into lock ups because they have a huge investment in the assets and because their cost basis is so low — they still have a big gain even if the IPO hasn’t performed.”
That can exacerbate a stock dip if people see “smart money” like venture capital selling, he said, creating a false narrative that investors are getting out because a stock is under-performing. In this case, they don’t have much of a choice because “the job of a venture capitalist is to get their money back their investment back and move on to the next thing.”
Employees often have stock options to buy shares below the IPO price. Tech engineers, for example, might sacrifice stability of a Google or Amazon for a stake in a young company that can pay off big in an IPO. As these companies stay private for longer (a decade in the case of Uber), employees are ready to get some liquidity by IPO day.
“The average employee probably has the vast majority of their personal wealth in stock,” Colas said. “Prudent financial management says you wanted diversify — so selling is not really optional.”
The dotcom bubble offers a cautionary tale. Shares of internet companies ran up because there was a shortage of stock. As lock-ups expired, that shortage went away and public investors went from being able to buy 5 percent of the company in public markets to buying 30 or 40 or 50 percent, Colas said. Still, today’s IPO market doesn’t have the ability to rock bellwether tech names that dominate the S&P 500’s market cap.
“If a bunch of IPOs is don’t work, it doesn’t mean much for Google stock or Microsoft stock,” Colas said.
Larry McDonald, founder and editor of research platform “The Bear Traps Report,” pointed to Facebook as a more recent example. Shares of Facebook dropped 4% in 2012 as companies were suddenly allowed to sell 230 million shares six months after the lock-up period ended.
“The market wasn’t that great to begin with, then there was an immediate impact from that lock-up,” he said.
McDonald said this may affect the future IPO window, since the psychology of going public is often driven by how recent stocks have performed.
“This does impact the stock price, and could affect one of these start-ups that’s looking to go public and saying ‘wow — there’s even more pressure on the stock… I’m going to wait until 2020 or put off an IPO even further,” he said. “It incentivizes a CFO to put if off until next year.”
The lock-up issue is one reason Bill Gurley, partner at venture firm Benchmark, and others have rallied around direct listings. The venture capitalist said on CNBC last month that the IPO process was a “bad joke” for Silicon Valley. Gurley gathered more than 100 CEOs of late-stage private tech companies, along with another 200 or so CFOs, venture capitalists and fund managers for an invitation-only event in San Francisco called “Direct Listings: A Simpler and Superior Alternative to the IPO.”
Mark Goldberg, partner at Index Ventures, said with direct listing there is no lock up period “so buyers and sellers can meet on day one of trading without any distortion — it’s much cleaner.”
“The money currently trapped in lock ups weighs heavily on recent IPOs, even if current investors decide to hold beyond the lockup, the public markets are forced to guess which direction they will go,” Goldberg said. “That uncertainty creates volatility. A direct listing helps a company find its financial equilibrium faster.”
Lyft’s lock-up ended on August 8. While shares held up that day, the stock has dropped roughly 40% since the lock-up expiration date.
Tom White, senior research analyst at D.A. Davidson, said Lyft’s weakness was more about general “de-risking” in the market as opposed to the lock-up expiration date.
“I generally think of these expirations as more of a short-term headwind for a newly public company’s shares,” White said. “For Uber, as in Lyft’s, case, given how long it was a private company, I suspect some of the early investors are sellers of the stock effectively at any price.”
McDonald echoed that sentiment and said IPO market weakness is more about equity investors shunning risk in search of defensive names, especially as trade war uncertainty drags on. IPOs, for the most part, are squarely in the risk category.
“Every single nook of the market that is risk-oriented is getting nailed right now,” he said. “It’s just an indicator of what the market is going through.”