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Tilray is getting slammed as its IPO lock-up period expires. Here's what an IPO lock-up period means. (TLRY)

Tilray
  • Tilray plunged more than 10% Tuesday after its initial-public-offering lock-up period expired, allowing early investors to sell shares from its July public listing .
  • IPO lock-up refers to the 90- to 180-day window after a company has gone public when insiders including company executives, founders, employees, and venture funds are barred from selling their shares.
  • The purpose of an IPO lock-up is to ensure that shares owned by these insiders don't enter the public market too soon after the offering, according to the regulators.
  • Companies can use the lock-up period to post up to two consecutive earnings report, clarifying its business operations and outlook.
  • When the lock-up expiration nears, i nvestors who are concerned about a potential price drop may hedge their position, through ways such as buying options.

But what exactly is an initial-public-offering lock-up period, how long is it, and why were Tilray shares getting hit when it expired? To fully understand how the lock-up period and its expiration may impact investors it's important to understand the mechanics of the lock-up and the rationale for having one.

The US Securities and Exchange Commission regulates that company insiders who acquire shares of a company before it goes public are barred from selling their holdings for a set period of time. Regulators may also limit the number of shares that can be sold over a designated period of time. Insiders can be company executives, founders, employees, venture funds or other early private investors.

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This waiting period, called the "lock-up period," usually lasts 90 to 180 days after the company has gone public. For example, Tilray began trading on the Nasdaq on July 19 , and its lock-up period was for the 180 days after its IPO.

Usually, once the lock-up period expires, most trading restrictions do not exist.

The purpose of an IPO lock-up is to ensure that shares owned by these insiders don't enter the public market too soon after the offering, according to the regulators.

This cooling-off period can help reduce the volatility of the new stock and allow for the market to price shares based on natural supply and demand. Typically, company insiders own a lot more shares compared to the public market. Therefore, if large shareholders are allowed to off load holdings immediately after the company goes public,their selling activities could drastically depress the stock's price.

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And that's why a company's stock price usually drops when the lockup expires. But the price change won't be too unpredictable then as the company can use the lock-up period to post up to two consecutive earnings reports, clarifying its business operations and outlook.

Usually, when a lock-up expiration approaches, insiders need to decide whether to sell their shares and book the profits or losses or to stick it out. Investors who are concerned about a potential price drop may hedge their position, through ways such as buying options.

And outsiders may short the stock, or betting against it, as they anticipate the price to drop. That's also why a stock's borrowing cost usually rises when the lock-up expiration nears.

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