DLJ Lockup Policy Aims to Ease Dumping 180 Days After IPOs

Investment bank Donaldson Lufkin & Jenrette (DLJ) is attempting an initial public offering lockup policy that lets venture capital backers sell parts of their stakes sooner than current structure permits, but only if the stock price has appreciated.

Lockup expirations have roiled newly issued stocks as investors often try to dump shares before the standard 180-day bar is lifted on selling by insiders and venture capitalists. Red Hat (RHAT), for example, saw its stock drop 35% in the month before its lockup expired as investors anticipated heavy insider selling, in an instance demonstrating how managing such periods has become crucial.

DLJ, in an attempt to smooth this kind of volatility, is using the $58 million IPO of Embarcadero Technologies to try a plan that allows holders who aren't "officers, directors or affiliates of Embarcadero" to sell shares sooner than 180 days.

It won't be the first of its kind, but its picking up on a similar idea Morgan Stanley Dean Witter (MWD) built in to its offering of Avanex (AVNX) in early February.

Scott Sipprelle, president of IPO specialist firm Midtown Research, says DLJ's staged-step, performance-based plan makes sense. "Why have an arbitrary point in time when the public float doubles?"

According to Embarcadero's offering documents, nonrestricted shareholders, typically venture capital firms, would be allowed to sell 25% of their holdings 90 days after the IPO, and another 25% 135 days after. The remaining 50% then would become eligible for sale after 180 days.

Both the 90-day and 135-day share sales are conditional upon the stock having risen from its initial offering price, according to Embarcadero's prospectus, filed Feb. 22 with the Securities and Exchange Commission. And while it doesn't specify a range for the share price, the prospectus states the earlier-stage sales will be allowed if "the average price of our shares appreciates by a specified amount" after the IPO.

Wall Street has been recently wrestling with the impact of lockup expirations as investors increasingly focus on the date as one on which they expect the stock will drop precipitously. Indeed, the market has been flush with secondary stock offerings, some coming before the 180-day period ends, in which insiders and venture capitalists use the offering to sell a portion of their shares.

While Wall Street firms have experimented with variations on the lockup theme, the Embarcadero offering marks the first time a formal, early lockup plan has been linked to strong stock performance. In the IPO of Webvan (WBVN), for example, inside shareholders were allowed to sell some of their shares before the lockup even though the stock hadn't moved much from its offering price at the time. Webvan shares closed at 12 9/16, down 1/16, on Friday.

DLJ chose to revise its standard lockup procedure because venture capitalists and insiders wanted an exit structure that created less volatility for the stock, says one DLJ investment banker who requested anonymity. The staged-step lockup may become standard issue on future DLJ-led IPOs if it's well-received in the Embarcadero offering.

"The venture capitalists and the company insiders love it, because if the stock doubles in price, they can take some money off the table without sending the share prices off a cliff," the banker says.

In addition to the obvious boon to the selling shareholders, the staged-step lockup also benefits the company and its overall shareholder base by cutting down on volatility and ambiguity, proponents say. A staggered lockup process, linked to the stock's performance, likely would mean that individual investors would be less afraid of such selling dates and less likely to bail out of the stock in anticipation.

On occasion, investment bankers eager to please venture capitalists and company insiders will unshackle insiders from lockup agreements, often to the chagrin of other shareholders. For example, eToys (ETYS) insiders were released from their lockup in October, when the stock was around 70; the stock has dropped 80% since that time.

The staged-step lockup at least spells this process out well in advance of the IPO.

"I'd much rather go into a situation where I knew the rules ahead of time," says Jake Reynolds, a partner at Technology Crossover Ventures, a Palo Alto, Calif., venture capital firm. Technology Crossover is not a major shareholder in Embarcadero.

Although DLJ may have gotten out of the gate first with the performance-based feature, other investment banks are working on similar alterations to the lockup process, says Reynolds, suggesting that this is one problem Wall Street wants to solve. "Investment banks are just trying to reduce the overhang. If everybody rushes to the door on Day 181, it doesn't help anybody."