Lock-up Agreement
Forbids insiders of a business from selling their shares for a predetermined amount of time.
What Is a Lock-Up Agreement?
A lock-up agreement forbids insiders of a business from selling their shares for a predetermined amount of time. They are frequently applied in the course of an initial public offering (IPO). An IPO is when a private corporation issues new stock to the public for the first time.
Although they are not required by federal law, these agreements are frequently requested by underwriters from executives, venture capitalists, and other business insiders to avoid undue selling pressure during the initial months of trading after an IPO.
The prospectus materials always include information on the terms of the business' lock-up agreements. These documents can be obtained by contacting the company's investor relations department.
Another way is using Electronic Data Gathering, Analysis, and Retrieval (EDGAR). EDGAR is a database kept up by the Securities and Exchanges Commission (SEC).
All insiders may occasionally be "locked out" simultaneously. In other instances, the agreement will have a staggered lock-up structure wherein various classes of insiders are kept out for various lengths of time.
Note
Lock-up times are usually 180 days long but occasionally range from 90 days to one year.
These agreements are mostly used to stop other business insiders from selling their shares to new buyers in the following days and weeks, right after an initial public offering.
Some of these insiders might be early investors, like venture capitalist companies, who invested in the business when its value was much lower than its IPO value. As a result, they might indeed have a good reason to sell their shares and profit from their original investment.
Similarly, certain workers and business executives might have received stock options as a condition of their employment contracts.
These employees, like venture capitalists, might be persuaded to exercise their options and sell their shares because the IPO price of the company would almost definitely be significantly higher than the exercise price of their options.
According to studies, a time of abnormal returns usually follows the termination of a lock-up agreement. Unfortunately for investors, these abnormal returns tend to go the wrong way more frequently.
Surprisingly, some of these studies discovered that lock-up contracts with multiple expiration dates can have a detrimental effect on a stock more than those with a single one.
This is unexpected because staggered lock-up arrangements are frequently considered a remedy for the post-lock-up dip.
Impact of Lock-Up Agreement
Lock-up agreements are designed to help safeguard investors from a regulatory standpoint. The lock-up agreement is designed to prevent the situation in which a group of insiders flogs an overvalued business to investors and then flees with the money.
This was a genuine problem during several periods of market euphoria in the US, which is why some blue sky statutes still stipulate lock-ups as a requirement.
Investors who are not insiders of the business may still be impacted even when a lock-up agreement is in place once it has passed its expiration date. This is because company insiders are allowed to sell their stock after lock-ups end.
Because of the enormous rise in stock supply, the share price may fall dramatically if many insiders and venture capitalists decide to sell.
It is important to note that an investor can choose to deal with this in one of two ways, depending on how they might feel about the underlying business.
- If the post-lock-up drop does materialize, it may present a chance to purchase shares at a momentarily lower price.
- Conversely, it might be the initial indication that the IPO was overpriced, kicking off a protracted fall.
According to underwriters, insiders must sign a lock-up agreement before a business is permitted to go public. The goal is to keep the company's stock steady in the initial months following the sale.
Following the IPO, the procedure guarantees an orderly market for the company's stock. It gives the market enough time to determine the stock's true value. Additionally, it ensures that insiders continue to behave in a way that advances the company's objectives.
Sometimes a lock-up clause must be approved by the business acquirer during the sale of a controlling interest. For the duration of the agreed lock-up time, it prohibits the sale of assets or stakes. The action aims to keep prices stable for other parties.
Businesses undergoing hostile takeovers occasionally follow a similar path. Only after the lock-up time has passed can the restricted or "locked" stakeholders sell their shares. This helps stop some insiders from engaging in opportunistic behavior and trying to sell the stock for less.
Lock-up agreements are made to safeguard investors and are agreements on investors. The lock-up agreement aims to prevent a situation in which a few insiders sell an overvalued business to investors while making off with profits.
Those who intend to invest in the business must know the end of the lock-up period. This is because insiders selling some of their shares could cause stock in the business to decline.
Additional provisions may restrict the number of shares that can be sold within a certain time frame following the agreement's expiration date that might be included in the agreement.
Such provisions assist in preventing a material decline in share prices that might follow from a substantial increase in supply.
Lastly, investors need to be aware of any agreements because there is a high likelihood that the stock price will decline or decrease once it ends.
Blue Sky Laws
Even though lock-up periods are not mandated by federal law, they may still be required by state blue sky laws. Blue Sky laws are state rules created to protect consumers from securities fraud.
Sellers of new issues are generally required by law, which may differ by state, to register their offerings and provide financial information about the transaction and the parties involved.
Investors can then base their judgment and financial choices on a wealth of verifiable information.
Brokerage companies, financial advisors, and individual brokers who sell securities in their states typically need licenses under blue sky laws. This is an additional regulatory layer along with federal securities laws, like the Securities Act (1933) and Exchange Act (1934).
Private investment funds must register under these laws not only in their native state but also in each state in which they intend to conduct business.
Securities issuers are required to make public the conditions of the offering, including disclosures of any pertinent information that could impact the security.
Due to the state-based nature of these laws, various filing requirements for registering offerings may exist in each jurisdiction. In addition, state agents typically conduct a merit evaluation as part of the procedure to determine whether the deal is reasonable and fair to the buyer.
The laws' provisions also make issuers liable for false claims or information not disclosed, opening them up to lawsuits and other legal actions.
Such laws are intended to prevent sellers from taking advantage of novice investors and ensure that investors are presented with offers for new issues that have already been reviewed for justice and equity by their state administrators.
Additionally, these laws have antifraud provisions that create liability for fraudulent statements or failure to disclose required information.
Lock-Up Agreement FAQs
A lock-up agreement forbids insiders of a business from selling their shares for a predetermined amount of time.
These agreements are mostly used to stop other business insiders from selling their shares to new buyers in the following days and weeks, right after an initial public offering.
An initial public offering (IPO) is when a private corporation issues new stock to the public for the first time.
Lock-up times are usually 180 days long, but they occasionally range from 90 days to one year.
Blue Sky laws are state rules created to protect consumers from securities fraud.
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