May 23, 2012

Facebook Had No Lock-up Period: Why?

Filed under: Business Moves,Economy,Taxes & Government — Tom @ 2:45 pm

Much hay is being made about that fact that Facebook founder Mark Zuckerberg and other insiders were able to sell some of their shares in the company on the open market as soon (if not just before, which I suppose is a point requiring investigation) as the company’s stock began public trading.

As I understand it, the insiders’ plans to do this were clearly disclosed in the S-1 prospectus.

We’re supposed to believe that there’s nothing unusual about what they did.

That is flat-out wrong, as Investopedia explains:

When companies “go public”, the number of shares offered in the initial public offering (IPO) is typically a relatively small portion of the overall ownership. The balance of the shares is held by insiders, which include management, founders and venture capitalists (VC) who funded the company while it was private.

The exact number of shares that is offered in each IPO will differ from company to company. For example, in 2004, Google offered 7% of its shares to the public, while Vonage offered 20% of its shares to the public during its 2006 IPO.

… although the number of shares offered will differ from one IPO to another, nearly all IPOs have some sort of lock-up period. A lock-up period is a caveat placed on insiders and pre-IPO holders that prevents them from selling their shares for a set period of time after the company has gone public. A typical lock-up period is four to six months.

My understanding and experience (admittedly a bit dated) is that it’s not at all unusual for lock-up periods to be as long as two years.


There is no federal law or Securities and Exchange Commission requirement that forces insiders or pre-IPO shareholders to be “locked up”, but the investment banks underwriting the IPO almost always request it so that insiders do not flood the market with shares right after the company’s initial public offering. The lock-up in the prospectus (Form 424B4) is a contract between the insiders and the purchasers of the IPO, so it is highly unlikely that it would be violated.

This information is disclosed in the S-1 when the IPO documents are filed with the SEC. The best sources for lock-up information are the SEC website and several paid services including Edgar Online. The lock-up period will be stipulated in the prospectus, called the S-1, but it is very important that investors watch each revision of this document, called S-1As, because there could be a change in the lock-up terms.

… As a company goes public, underwriters want to be able to see what outside investors believe the new entity is worth based on information like that found on the balance sheet, the income statement (profits and losses) and executive overviews of the business (business risks).

If inside investors are allowed to sell immediately at the time of the IPO, it may well obscure the price that the markets put on the company by putting selling pressure on the shares on the first day of trading.

Hmm. Isn’t that what just happened?

All of this in my view raises serious questions about the Facebook IPO:

  • Why did the founders and other key players insist on avoiding the normal lock-up?
  • Why did the underwriters let them? It’s against the underwriters’ interest to allow this, because doing so makes it in the founders’ personal self-interest (even beyond already-existing corporate self-interest) to overvalue the company and to fudge the financial and nonfinancial data to support the overvaluation. In Facebook’s case, the nonfinancial data about hits, subscriber growth, and the like are particularly important. If enough of the ownership stake is involved, it also exposes the public to the founders losing interest in managing the company well.
  • Does the founders’ and other key players’ insistence on no lock-up period betray a fundamental lack of faith in Facebook’s long-term prospects? I don’t see how you can interpret it any other way.
  • Finally, a free-market believer would certainly agree the SEC can’t (and at least in theory shouldn’t) stop such an arrangement — unless there is some kind of conflict of interest with the potential to shortchange the public involved. Was there? A clear possibility exists. Goldman Sachs was a major investor in Facebook, is a major underwriter of IPOs, and a major investor in other businesses. The lack of a lock-up period would seem to have benefit Goldman Sachs bigtime. The rest of the underwriting community may not have had the gumption to challenge what should have been challenged because it needs Goldman’s cooperation to make other IPOs and investments happen.


  1. Shoulda gone short.

    Comment by Alo Konsen — May 23, 2012 @ 4:45 pm

  2. [...] Facebook Had No Lock-up Period: Why? [...]

    Pingback by Facebook Had No Lock-up Period: Why? | PERSUASION IN INK — May 23, 2012 @ 8:53 pm

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