The Australian Stock Exchange (ASX) has made welcome changes to its rules around post-IPO lock-ups. But do they go far enough? While a strong regime benefits new investors and market integrity, is the position globally competitive? Do we risk losing IPOs to other jurisdictions?
If Australia’s regime is not globally competitive, we risk losing Australian companies and founders, and could struggle to attract overseas seed capitalists and pre-IPO investors.
What is post-IPO lock-up?
In the context of an initial public offering (IPO), post-IPO lock-ups prevent a holder of a security interest from dealing with their securities for a period of time following the company’s listing. In Australia, these are formally known as ‘restriction agreements’ or more colloquially as ‘escrow’. The rationale is to prevent founders and other key shareholders, who may have acquired their stake at a lower valuation than IPO participants, from exiting as shareholders straight after the IPO.
ASX applies (and enforces) mandatory restriction requirements on deemed ‘restricted securities’. Mandatory restriction may also be supplemented by voluntary escrow, which may extend to additional securities or for different time periods. The term ‘voluntary’ is somewhat of a misnomer and the position is typically negotiated between the shareholders, company and the manager or underwriter of the IPO, having regard to market practices.
Under the mandatory regime, ASX has determined that for entities who are not listing under the ‘profits test’ or otherwise able to demonstrate a track record of profitability, specified categories of investors
(primarily founders, seed capitalists, related parties and promoters) must have their securities restricted for a stipulated period of 12 or 24 months. This is moderated by a proportionate ‘cash formula’ which applies where shares have not been acquired at the same price as which they are offered under the IPO prospectus.
As noted above, voluntary escrow may also apply. These arrangements assist in demonstrating the restricted parties’ confidence in, and ongoing commitment to, the company. In its simplest form, voluntary escrow may be applied to the balance of a shareholder’s securities not covered by compulsory escrow and for an equivalent period. For example, if a shareholder has 75 per cent of their securities subject to compulsory escrow for 24 months, the balance of 25 per cent would be subject to the voluntary escrow.
Alternative timing benchmarks may be negotiated as well, potentially referable to particular milestones, or release of audited financial results relevant to the IPO valuation or forecasts.
Purpose of restriction arrangements: ASX perspective
Restriction arrangements are effective because, as ASX confirms, they:
- ‘reduce the opportunity and incentive for those who have provided seed capital to a new or re-compliance listing and who are likely to have paid a substantially lower price for their restricted securities than incoming investors, from making a windfall profit on those securities at the expense of the incoming investors’
- ‘align the economic interests of the entity’s related parties, promoters and seed capitalists with those of the incoming investors for the duration of the escrow period’ and
- ‘ensure that professional advisers and consultants who perform a quasi-promotional role by advising the entity on a new or re-compliance listing and who receive securities in the entity for services rendered are treated on the same footing as promoters’ and
- for re-compliance listings, ‘reduce the opportunity and incentive for related parties, promoters and their associates to vend a classified asset of uncertain value into a new or re-compliance listing and make a windfall profit at the expense of the incoming investors’.[i]
In short, potential IPO investors are afforded some protection that they are not going to be buying shares in a company where the founders and promoters will ‘dump and run’.
What changes have been made?
In December 2019, ASX implemented key changes to the Australian escrow regime, in particular Chapter 9 of the Listing Rules, including:
- providing further clarity as to how the mandatory escrow regime operates. In particular, ASX will not ordinarily impose escrow on entities:
- admitted under the profits test
- that have a track record of profitability or revenue or
- that have a substantial proportion of its assets as tangible assets or assets with a readily ascertainable value
- clarifying how mandatory escrow arrangements differ based on how significant a securityholder is streamlining mandatory escrow requirements so that an entity can include escrow provisions in its constitution for less significant holders rather than needing to enter into restriction agreements.
These changes have been of significant benefit, reducing the time, cost and complexity of securing signed restriction agreements. In some cases, this involved potentially hundreds of security holders and risked exposure to potential ‘greenmail’ tactics.
In August 2020, ASIC followed suit and announced welcome regulatory relief to reduce additional cost and administrative hurdles for companies undertaking an IPO by creating an exception to the takeover provisions set out in chapter 6 Corporations Act 2001.[ii] Previously, voluntary escrow arrangements could result in a company obtaining a deemed relevant interest in its own securities. Where that relevant interest exceeded 20 per cent, entities needed to seek individual relief from ASIC in respect of its voluntarily escrowed securities. The new ASIC Instrument relief means the relevant interests of the company, underwriter or lead manager pursuant to voluntary escrow arrangements in connection with an IPO may be disregarded for the purpose of the takeover provisions, provided certain conditions are met.
Who is affected?
ASX has identified specific categories of security holders to whom securities were issued well below market value and to whom mandatory escrow restrictions shall apply.
These include:
- Seed capitalists — who are issued securities tied to the listing where the consideration paid for the securities is cash or a conversion of debt to equity
- Vendors of classified assets — who may be issued securities either before or after listing. Consideration paid for the classified assets can be either the classified assets themselves or cash (which must be used to pay for the relevant classified assets)
- Professionals or consultants — who are engaged to provide services to the Issuer either before or after listing. Consideration paid for the classified assets can be either the classified assets themselves or cash (which must be used to subscribe for the relevant securities)
- Associates — including anyone related to the entity or its promoters who are issued securities tied to the listing pursuant to an employee incentive scheme
- Other recipients — including any person to whom restricted securities are transferred before or after listing which have particular conditions attached.
The restrictions are not limited to these categories and it is important to remember that ASX has a discretion to apply escrow restrictions to anyone it deems appropriate to do so.
Does this adversely impact certain sectors?
More broadly, mandatory restrictions are imposed in relation to IPOs of early stage and other start-up or speculative businesses admitted under the assets test that do not have a track record of revenue or profitability acceptable to ASX. Early stage and pre-revenue businesses are particularly impacted by the relatively onerous escrow conditions. This means the compulsory escrow requirements are most likely to be an impediment to sectors such as:
- technology
- biotechnology and life sciences
- mining exploration.
How do we compare with other countries?
The reforms have had an impact in the reduction of red tape faced here in Australia. Our framework is still comparatively stringent on a global scale and there remains a significant disparity between Australia’s escrow rules and those of other leading financial markets. This is manifest in two aspects: the period of escrow and who it covers.
The following table outlines some of the key restrictions that apply to entities listing on the ASX as generally compared to other leading foreign exchanges:
| Jurisdiction | Person | Restricted securities | Time period |
| Australia (mandatory) | Seed capitalist who is a related party or promoter or associate of related party/promoter | Ordinary securities for which the recipient has paid a cash amount that is not less than the price paid for such securities in any IPO —none; Securities to which the cash formula applies; or Other securities — all. | 24 months |
| Other seed capitalists | Ordinary securities for which the recipient has paid a cash amount that is not less than 80% of the price paid for such securities in any IPO — none; Securities to which the cash formula applies; or Other securities — all. | 12 months | |
| Related party or promoter vendor | All | 24 months | |
| Other vendoers | All | 24 months | |
| Professional adviser or consultant | All | 24 months | |
| Person under employee incentive scheme who is a related party or promoter | Securities to which the cash formula applies; or Other securities — all | 24 months | |
| Australia (voluntary) | Any person | Determined under the voluntary restriction agreement | |
| United States | Any person -securities are often subject to voluntary lock-up terms imposed by the company and its underwriter | All | 6 months |
| Hong Kong | All | 6 months- cannot dispose of any interests; A further 6 months – cannot dispose of any interests that would cause it to cease to be a controlling shareholder | |
| New Zealand | Vendor or major security holder will be prohibited from taking steps which would cause the effective control of the securities to be disposed of for an agreed period of time | N/A | |
| Singapore | Promoters (controlling shareholders and their associates or executive directors with 5% or more interest) | Promoter — all and then 50% of original shareholding; Investors who acquired securities less than 12 months prior to listing — proportion of shareholding calculated using cash formula; Investors connected to sponsor of IPO — All | 6 months and then an additional 6 12 months 6 months |
| United Kingdom (LSE main market) | Any person -underwriters typically require directors and major selling shareholders to agree to a voluntary lock-up arrangement | All | None |
The way forward
ASX is to be congratulated for its reforms to the mandatory restriction regime. Clearly Australian entrepreneurs and advisers have become adept at navigating the regime. Increasingly however, global capital flows mean companies seeking to list have a range of options as to which exchange and jurisdiction they may seek to list in. Entrepreneurs who have experienced the relative simplicity and reduced impost of other jurisdictions may increasingly seek to IPO in other countries. Can the Australian regime be further simplified to maintain Australia’s reputation as a great market for IPOs?
Notes
1 ASX Guidance Note 11, paragraph 3.2
2 ASIC Corporations (Amendment) Instrument 2020/72