Generally, when you own shares in a company or some other type of investment vehicle, you have some expectation that, depending on market conditions, you’ll be able to control the disposition of your shares. However, following initial public offerings (IPOs) and other key periods, such sales could be damaging to, or problematic for, the issuer. Lock-up periods were established to protect against this problem. If you are considering an investment subject to a lock-up period, it may be helpful to discuss the issue with a securities and financing lawyer. Priori Legal can help you find an experienced attorney who fits your needs.
What Is a Lock-Up Period?
A lock-up period (or a lock out period as it is sometimes called) is a specified period of time after an investment during which shares cannot be redeemed or sold by the particular holder. The lock-up period is intended to stabilize share price or enhance investor confidence, either by preventing shares from flooding the market, keeping a fund from requiring high amounts of cash on hand or preventing certain key people from signalling to the market that they want to sell their positions during certain key times. Importantly, not all trading ceases during the lock-up period. Rather, only those holders who are subject to a lock-up are prevented from selling.
When Is a Lock-Up Period Used?
A lock-up period is a typical part of many investments. Almost all closely held investments have a lock-up period for new investors who buy in, as do new public companies.
IPO lock-ups are perhaps the best-known type of lock-up period. After a company goes public, newly issued and newly public shares often cannot be sold for 90-180 days after they are first listed. This policy is in place to prevent shareholders with a large ownership percentage from flooding the market with shares during the initial trading period. The IPO lock-up period also stabilizes the share price during the least stable part of the a public company’s existence.
Hedge Fund Lock-up
Hedge funds and other closely-held investment vehicles also have a lock-up period, but hedge fund lock-up periods are much longer than those of IPOs. A typical hedge fund lock-up usually lasts about two years. The reason for this long lock-up period is that underlying investments of hedge funds are often illiquid. If investors could pull out early, fund managers (and the other investors) would take a big hit when delivering the cash to exiting investors. Instead, the long lock-up period allows hedge funds to make longer-term investments with potentially larger returns.
Key Player Lock-up
Sometimes, certain individuals are subject to a lock-up based on their individual agreements with a company. For example, a CEO may be subject to a lock-up during certain key times for the company in order to prevent giving negative signals to the market.
To ensure that the lock-up period is respected, all parties must sign a lock-up agreement. The lock-up agreement is simply a contract that establishes the duration of the lock-up period. In IPOs, the lock-up agreement is contracted between underwriters and company shareholders to protect the share price while the underwriters are taking on the risk.
Why is the lock-up expiration important?
Because the date of the lock-up expiration is the first time that shareholders can pull out of an investment, the lock-up expiration can cause instability in an investment vehicle or a dangerous depression of share price as stocks flood the market.