Facebook, LinkedIn and Angie's List are all so-called Web 2.0 stocks. But they're vulnerable to the same hazard that took down a lot of Web 1.0 stocks the last time around.

That's the dreaded stock-killing monster known as a "lockup release."

Fortunately, there are ways to avoid this risk and even use it to your advantage to make money. I'll explain how in a moment, then take a look at upcoming hurdles facing some hot Web stocks. But first, what's a lockup release?

Predictable drops

To ward off heavy selling by early investors and insiders right out of the gate on an initial public offering, investment banks and companies order these folks not to sell right away -- to "lock up" their stock.

Typically these lockups -- which are disclosed in filings -- last for 90 or 180 days.

After that, all heck can break loose. Insiders -- hungry for profits, or worse, gloomy about the outlook for their companies -- can rush for the exits. Predictably, their stocks tank under heavy selling. Consider the damage done by lockup releases at three of the social-networking, Web 2.0 companies the market was hot on not long ago:

Image: Shadow © Stewart Charles Cohen, Getty Images

● When a Facebook (FB) lockup expired Aug. 16, selling spiked, and the already-disappointing stock tanked. Volume jumped to 100 million to 150 million shares a day for three days, compared with an average of about 30 million before that. Facebook stock fell 13% by Aug. 20 to under $19, from above $22 on Aug. 13, a few days before the lockup release. Typically, lockup-related weakness kicks in several days early, as investors see it coming and sell beforehand.

● At Angie's List (ANGI), the popular online consumer-review site, things got even uglier. Its lockup expired Aug. 14. Volume spiked to 3 million shares, compared with daily volume of around 400,000 before. The stock fell to about $11 from a close of $13.29 the day before. And it just kept falling to around $9, for a tumble of more than 25%.

● LinkedIn (LNKD) fell from $80 a week before its Nov. 21, 2011, lockup release to $56 a week after, for a 30% decline.

Image: Michael Brush

Michael Brush

Though lockups are back in the news now, they are really old hat. I remember tracking them during the tech bubble, before that broke a decade ago, for potential buys on the pullbacks. The declines tied to lockup releases were potential moneymakers. You could, for example, buy when stocks dipped and sell when they'd bounced back.

Is it different now?

But there's a troubling new twist these days. Many Web 2.0 stocks are falling harder on the lockups, and they are not getting up again. At least not right away. Why the more extreme reaction this time around? Experts cite these reasons:

  • Low floats at high prices. A lot of social media companies are issuing just 5% to 10% of their available stock in the initial public offering, creating a small stock float, with relatively few shares on the market. They've also been coming out at high valuations relative to measures such as cash flow, sales and profits, points out David Rudow, a tech sector analyst for Thrivent Financial for Lutherans. That's a recipe for a selloff on a lockup release, since putting more shares out creates selling pressure. "When the unlock happens, there is just a flood of shares," he says.
  • Bad memories. "A lot of the venture capitalists behind the social media companies worked during the 1990s," says Tom Taulli of IPO Playbook. "So from prior experience, they realize that wealth can evaporate quickly in new technologies." If there are some gains on the table, they are more inclined to take them by selling.
  • Bad news. Many Web 2.0 companies have run into trouble, and this casts a pall on the sector. This makes insiders and early investors eager to cash out as soon as their lockups expire -- which means more shares for sale and lower prices. Groupon (GRPN), the online coupon company, fell hard on Aug. 14 on bad earnings news and a weak outlook. Zynga (ZNGA), the company behind Facebook games such as "FarmVille," and "CityVille," did the same in late July. "There are no positives," Stifel Nicolaus analyst Jordan Rohan said of Zynga's second-quarter results, just after they were announced. "Annual guidance was simply gutted. The competitive advantage Zynga enjoyed appears to have dissipated." Likewise, Facebook failed to post the upbeat sales outlook many had been looking for when it announced second-quarter results, and many wonder how it can make money in the mobile space.
  • Privileged exits. There's another troubling new twist on the lockup release at Web 2.0 companies, namely special early releases for a privileged few insiders. This makes outside investors, and insiders without the privilege, even more antsy.

Need an example? At Zynga, CEO Mark Pincus and some other execs wrangled a waiver from bankers that let them sell in early April, about two months ahead of the scheduled lockup release. This allowed them to sell at just under $12, while others at Zynga had to wait for an early June release. By then, the stock was at $6.

Pincus alone dumped 16.5 million shares at $11.64, grossing $192 million, according to Thomson Reuters. Thus, he dodged a $93 million loss. By August, Pincus had purchased a $16 million house in the posh Pacific Heights section of San Francisco, home of tech billionaires. Does this seem fair? Zynga declined to respond, but during a conference call, investors were told that the business was in better shape when the exceptions were made, and then things deteriorated quickly.

To many, though, Pincus' pounding at the door to get out was a troubling sign. "How badly do you want to tell me that you don't want to co-invest with me?" asks Fabio Savoldelli, who teaches hedge fund investing at Columbia Business School.

Indeed, professional investors regularly watch lockups, and you should, too. "It's one of the many bits of information that a hedge fund will absolutely look at to see how much overhang there is in a stock," says Savoldelli. "Overhang" means share supply likely to hit the market -- in this case because of a lockup release.

How to invest in lockups

I'll assume most of my readers are looking at lockups as investors, not insiders. There are two basic ways to deal with lockups:

  • Use them for better entry points. "Do your research in advance and wait for the lockup to buy," says Rudow, at Thrivent. "Lockups are just another tool to buy something that you want to own for the long term." Anyone who waited for the LinkedIn lockup release in November could have gotten the stock in the $50 range instead of above $80 just a week before. With the stock at more than $100 a share now, you'd be up in either case, but you'd be happier if you bought at $50.

    Click here to become a fan of MSN Money on Facebook

  • Bet against companies just ahead of lockup expirations. The results can be great. Keep in mind that stocks often start declining days before the lockup expiration, as investors anticipate it. The shares of Bazaarvoice (BV), which helps companies analyze online commentary about their products, fell from $16 on Aug. 14, to $13.75 the day before its Aug. 22 lockup, which then took it as low as $13 that day. As I noted above, Angie's List and LinkedIn fell 25% to 30% around their respective lockups in August and November. You can bet against stocks by shorting them, or borrowing them to sell now, assuming you can replace return them later at a lower price. Or you can buy put options, which give you the right to sell someone a stock at a prearranged price. The value of puts goes up when stocks decline.

Of course, keep in mind that betting against stocks ahead of a lockup can be risky, because there's no guarantee a lockup will cause a stock to tank. These are relatively adventurous trading moves.