Upcoming Share Unlocks: What to Do and How to Know

Keep Track of Your Microcap Companies’ Locked Up Shares

If you’re old enough to remember what a stock certificate looks like, the concept of locked up shares might bring to mind how such paper stock certificates were typically locked up in a safety deposit box. Of course, an astute old-timer investor will understand that locked up shares actually refers to shares held by company insiders and major shareholders that cannot be sold for a specific number of days following the initial public offering that created the shares. 

As noted in our blog, “Share Structure: Using it to your Advantage,” locked up shares and their subsequent unlocking affects available float and trading liquidity. In fact, the available float in many microcap companies is kept artificially low during the first six months to a year after an IPO due to lock lock-up agreements. This can help boost share price gains during the early days, but can put the brakes on momentum when shares are unlocked.

Such downward pressure on share price is naturally perceived as a negative, but note that it also presents a buying opportunity. If you’re bullish on a particular microcap company’s longer range prospects, share price drops caused by share unlocks serve as opportune times to add to your position. As long as the company is executing on its business plan and seems to be following the script that will lead it to expanding revenues, any unlocked share-related selling pressure will likely soon subside.

On the other hand, if a lock-up expiration causes massive dumping by insiders it may be a clear signal that the IPO was overpriced and lead to a continued long-term decline. In extreme cases, such dumping might signify the equivalent of “Houston, we have a problem….”  

Knowing the dates of a company’s share unlocks can also help better determine the reasons behind specific share price action. Investors in microcap company NEXE Innovations (TSXV: NEXE.V) saw their shares drop in value on Monday, April 19^th by about 10% on higher volumes and then decline another 8% on the Tuesday. While there was no news driving the price action, almost five million shares were unlocked and joined the available float over the weekend. 

Given that the opening share price on the Monday did not represent a significant premium over the IPO price, there probably wasn’t a huge dump rebalancing from insiders’ selling of those unlocked shares. But perhaps enough needed to free up some cash to start the downward momentum. Some investors who were unaware of the share unlock might have been spooked by the initial selling and added to the downward momentum by selling their shares. 

Whatever the case, forewarned is forearmed as it’s always best to know every possible catalyst that might affect your microcap company’s share price.

Some might suggest a strategy of short selling the shares of a company with an upcoming unlock.  Shorters beware however, as shorting has an opportunity cost burden of tying up collateral as well as an uncapped potential downside.

An alternative would be to identify the right buying opportunity for a company you like.

Lock-Up Agreements—The Basics

Lock-up agreements are contractual provisions within IPOs that dictate when company insiders and major pre-IPO owners can sell their new shares on the open market. Lock-up periods can cover all share classes, warrants, and securities that are convertible to post-IPO shares. Lock-up agreements are also included as needed in most secondary offerings.  

These agreements are not crafted to comply with any U.S. or Canadian securities laws, but instead to mitigate risks for the underwriters of the IPO. That said, some company IPOs need to include lock-up periods in order to meet provisions within specific state and provincial regulations (known as “blue sky laws”) that protect investors from securities fraud. Overall, lock-up agreements are designed to:

• Ensure a stable market for the new securities.
• Limit trading volatility.
• Prevent an oversupply of the securities.
• Bolster market confidence in the newly public company.
• Ensure that insiders continue to hold a stake in the company.
• Protect investors. 

The structure of lock-up agreements is typically negotiated between the company and the underwriters, with details included in the IPO prospectus as filed according to applicable securities laws. While most lock-up periods are set at 180 days, they can be as short as a month and as long as several years. Some lock-up agreements lock up the sales for all insiders for the same period, while other agreements contain staggered lock-up structures that provide different periods according to investor insider class (such as venture capital firms with a large holding, company executives, employees with stock options, etc.). Lock-ups periods can also be staggered by share count, with specific percentages unlocked over time, such as 15% after 90 days, 25% after 190 days, 25% after a year, and the remainder at two years. 

Special Provisions and Exceptions

As a legal contract, lock-up periods can include any number of exceptions and provisions that ensure that the agreement does not impede company operations. For example, lock-up agreements have to allow for the sale of shares to the underwriters, otherwise the IPO will not likely happen. Other provisions and exceptions can cover:

• Equity compensation
• Acquisitions and joint ventures
• Coverage for pre-existing contracts
• Financial and estate planning
• Potential third-party takeover bid
• Post IPO open market purchases

Naturally, all such provisions are tightly negotiated by the underwriters and are crafted in the prospectus with all the commensurate legalese one would expect.            

Keeping Track of Share Unlocks

Given the latent power a share unlock has on share price movement, keeping track of lock-up periods should be an important tool in your company analysis and tracking toolbox. This holds especially true for microcap companies, which tend to IPO with very small floats that subsequently expand significantly over time with each tranche of share unlocks.

The forewarned-is-forearmed component of this tool is important, but equally important is tracking what the big players seem to do with their newly freed shares. The issuance price of those newly freed shares is known. As is the pre-share unlock share price and new available float count. What, you should ask yourself before the share unlock date, are the big dogs going to do? The bigger the sales profit margin, the bigger the likely dump. Thus, is it time to take part or all of your stake out and maybe try to get back in at a cheaper price? Or, if other elements of the company’s execution of its business plan seem especially wobbly, perhaps it’s time to seek other microcap opportunities. 

On the other hand, if everything about the company and its operations is whispering something like “ten-bagger” to you, then perhaps hold on during the potential downswing. If company insiders have similar sentiments, then any downward pressure may be limited, if not entirely absent. The key is to keep track of share unlocks and utilize it accordingly among your other analytical tools.

Finding Share Unlock Dates and Data

We’d like to say that you can find share lock-up data as easily as the stock price or a quarterly report. However, your favorite stock screener likely doesn’t carry it as a readily available data point and no online brokerages don’t offer it as a one-click easy to find item. All lock-up data and dates is included in the prospectus documents for a company’s IPO and any secondary offerings. Some companies kindly file such documents on their website investor pages, though many do not. For the latter, you can contact the company’s investor relations department or try searching the U.S. Securities and Exchange Commission’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database.

The Momentum Letter Introduces The Free Trade Report     

With the dearth of easy-to-access data on company share lock-up agreements and dates, The Momentum Letter will begin issuing “The Free Trade Report” to subscribers within the next few weeks that will include a section highlighting key share unlock dates and data for companies in the microcap and small cap space. To get your copy of the “The Free Trade Report,” subscribe today.

We are also taking subscriber feedback on what additional material to cover in this report as we plan to expand its coverage in the coming months.  Please let us know what you would find useful to have in a regularly updated consolidated report.