If investors do buy into the US$25 billion valuation reportedly being sought by Snap Inc, owner of the popular messaging app Snapchat, they will likely be paying for the most expensive tech initial public offering (IPO) to ever hit the market.
Just how expensive is it? Well, to give you an idea, it’s more than double of Facebook’s IPO and nearly four times of Google’s!
Investors are expected to bite. On Monday, the social media company revealed that it expected investors to buy up to a quarter of the shares in its US$3.2 billion IPO this week. The caveat is, they have to agree to not sell them for a year.
While Snap cautioned it had no binding commitments yet from investors accepting such a lock-up period, the disclosure is a sign of confidence from the company in what is expected to be the biggest U.S. IPO since Facebook Inc.
Breaking down IPO lock-down and why Snapchat wants its IPO investors to commit for a year
An IPO lock-up period is a contractual restriction that prevents insiders who are holding the company’s stocks before it goes public, from selling the stock after the company goes public. Insiders include company founders, owners, managers, employees and venture capitalists.
The Securities and Exchange Commission does not require companies that are going public to have a lock-up period. Rather, it is something that companies themselves request for to keep the stock’s price up.
- Moderates stock volatility
The purpose of an IPO lock-up is to prevent the risk of a stock selloff in the months following a company’s IPO. A stock selloff would result in the market being flooded with a large number of shares, which would depress the stock’s price.
This risk is particularly strong for companies in the technology sector. According to a Reuters analysis, eight of the 10 biggest technology IPOs fell between 25% and 71% in their first 12 months on the public market.
For example, Facebook’s IPO lock-up prevented the sale of 271 million shares during the company’s first three months on the public market. But Facebook shares hit an all-time low of US$19.69 the day its first lock-up period ended, a price about 50% lower than the share price on the day the company went IPO. Further restrictions prevented the sale of another 1.66 billion shares through mid-2013. Facebook’s unusual lock-up policy released insider shares at five different dates.
- Maintains appearance of faith
Another reason for the lock-up period is that large volume of sales by those closest to the company can give the appearance of a lack of faith in the company’s prospects, even when insiders simply want to cash in long-anticipated profits.
Also, insiders’ selling activities can have a particularly strong impact on a company’s share price when the company goes IPO because these stockholders typically own a large percentage of the company’s shares, with only a small percentage of shares being sold to the public.
There are cases where insiders cannot sell their shares even after the lock-up period ends because they possess material, non-public information and a sale would constitute insider trading. Such cases might occur, for example, if the end of the lock up coincided with earnings season.
- Signs of strong demand for Snap’s IPO
Most IPO lock-ups usually last between 90 to 180 days after the company goes public. So, Snapchat’s proposal for a year-long lock-up period potentially signifies strong demand for the IPO.
It is, however, not uncommon for a company’s stock price to drop permanently when the lock-up period ends and for its trading volume to increase substantially.
In its updated IPO registration document with the U.S. Securities and Exchange Commission on Monday, Snap was quoted saying that it expected approximately 50 million shares of its Class A common stock purchased by investors in the offering to be subject to a separate one-year lock-up agreement. The roughly 50 million shares are designated for new Snap IPO investors who do not currently have a stake in the company, sources who are familiar with the process told Reuters.
These sources also claimed that orders for Snapchat’s IPO have begun to come in at the high-end of its range and its “book” is already oversubscribed.