The cannabis industry has been a hotbed of investor interest over the past year, and marijuana stocks have seen dramatic levels of volatility. The ups and downs in the share prices of many of the best-known cannabis companies have shown just how speculative the space is right now, but it's also critically important to understand some of the mechanics involved with these young companies and how their shares trade.

On Jan. 15, shares of Tilray (NASDAQ:TLRY) plunged 17% as early investors in the marijuana producer got their first chance to sell shares into the public market. The expiration of what's known as a lockup provision, which extended about six months following Tilray's IPO, gave the green light to shareholders who had invested in Tilray when it was still privately held. Many top marijuana stocks don't face that threat, but several do, including the four mentioned below. First, though, let's look more closely at lockups to understand why they exist and what they mean for ordinary investors.

Cannabis leaf on top of a pile of $100 bills.

Image source: Getty Images.

The basics of lockups

Lockup agreements are designed to prevent company insiders and other early investors from selling off their entire positions in a stock immediately following a company's initial public offering. Even though the IPO process meets the legal and regulatory requirements to allow for the trading of company shares on public markets, the lockup agreement contractually prevents certain early investors from selling their shares for a set period of time.

A common period of time for lockups to last is 180 days, or roughly six months, as was the case for Tilray. After the lockup expires, shareholders that were subject to the agreement are then free to hold or sell at their discretion.

Often, insiders want to sell, and the expiration of the lockup agreement releases pent-up selling demand among those investors. That appears to be what happened with Tilray, with the 17% drop reflecting much more selling pressure than buyers were prepared to absorb.

Four cannabis companies facing lockups of their own

Most of the big names that marijuana companies are most familiar with are no longer subject to lockup agreements. Even some of the companies that are new to U.S. stock exchanges, such as Aurora Cannabis and Aphria, have longer histories of trading in Canada. Their listings on the New York Stock Exchange weren't true initial public offerings, instead only providing a dual listing source for shares that were already available on Canadian exchanges. There was therefore no need for further lockups.

Nowadays, many smaller cannabis companies are getting their shares listed by doing reverse mergers with companies whose shares already trade on established exchanges. In addition, some cannabis companies have used their stock to make acquisitions, and in those cases, the shares used in the buyout are sometimes subject to lockup provisions. The following four are among those that have recently taken such actions, and so their shares could therefore see downward pressure when those lockups expire.

Stock

Merger/Transaction Date

Lockup Period

Trulieve Cannabis (NASDAQOTH:TCNNF)

Sept. 25, 2018

120 to 180 days

MedMen Enterprises (NASDAQOTH:MMNFF)

Oct. 11, 2018*

6 to 12 months

Curaleaf Holdings (NASDAQOTH:CURLF)

Oct. 29, 2018

180 days

Acreage Holdings (NASDAQOTH:ACRGF)

Nov. 14, 2018

2 to 6 months

Data sources: Company filings. *Initial announcement date of acquisition.

The details are widely varied. Trulieve got its listing as a result of a reverse merger with Schyan Exploration, and Acreage Holdings merged with Applied Inventions Management to earn its listing. Curaleaf merged with Lead Ventures. For MedMen, the company's announced acquisition of PharmaCann included provisions under which some of the shares issued as payment would be subject to lockup provisions. Although the two companies have signed a definitive agreement, the deal hasn't yet closed, and MedMen said it could take six to 12 months to get the necessary approvals.

Are these marijuana stocks doomed to the same fate as Tilray?

Even with lockup agreements in place, there's no guarantee that these stocks will see similar declines to what Tilray experienced. The circumstances of each company differ, and disparities in their respective business performance could lead to different views among insiders.

Moreover, some companies might seek to extend their lockup agreements with key shareholders. For instance, earlier this week, Trulieve announced that the company founders had agreed to push the expiration date of lockups back to July 2019, stating that the founders had confidence in the company's business strategy.

What matters most is what the investors who own shares subject to the lockup provisions think about the company's future prospects. If they see the stock heading still higher, then they'll hold onto their shares, and the price shouldn't see any impact at all. But if they want to cash out at least part of their profits -- as often proves to be the case -- then big drops could follow once the lockup period expires.

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