Lock-up Period
A predetermined time following an initial public offering (IPO)
What is a Lock-Up Period?
A lock-up period is the predetermined time period following an initial public offering (IPO), during which company insiders, investors, and employees are not permitted to sell or redeem their shares.
It typically occurs when a private company gives its initial stock issuance to the public.
A publicly traded company's management and original large stockholders are prohibited from selling their shares immediately after an IPO.
Key Takeaways
- A lock-up period post-IPO restricts insiders from selling shares immediately.
- It curbs market volatility, allowing stock prices to stabilize and preventing oversaturation of shares.
- Lock-up periods range from 90 to 180 days, influenced by investment nature, with hedge funds having longer lock-ups.
- Companies using lock-ups are required by the US Securities and Exchange Commission (SEC) to disclose the terms in registration documents and prospectuses.
Factors and Regulations Influencing Lock-Up Periods
Businesses that want to go public are typically not required by legislation to adhere to a lock-up period. Instead, the business and/or investment banks underwriting the IPO typically request the lock-up period. The goal is to curb excessive volatility and let the stock market determine its real worth.
The fundamental investments of each fund determine hedge fund lock-up periods.
For example, a long/short fund that invests primarily in liquid stocks, for instance, might have a one-month lock-up time.
Event-driven or hedge funds typically engage in more illiquid securities, such as distressed loans or other debt, and frequently have long lock-up periods. Nevertheless, other hedge funds might not have any lockup restrictions based on how they invest their money.
Investors may redeem their shares on a predetermined timetable, usually quarterly, after the lock-up period. Normal notice periods range from 30 to 90 days. This allows the fund manager to liquidate underlying assets and make necessary payments to the investors.
However, the lock-up period is usually between 90 and 180 days, depending on the business.
Lockups used to be reasonably straightforward and typically lasted 180 days, but they are now progressively more complicated.
Employees and investors typically prefer shorter lockup periods to pay out sooner. Underwriting banks frequently request lengthier lockup periods to prevent insiders from lowering the share price. Typically, the business is in the center.
They do not want it to appear that insiders have little confidence in the stock. So they want to make sure the investors are satisfied.
The US Securities and Exchange Commission (SEC) has laws that require companies using lock-ups to disclose their terms in the registration documents and prospectus. In addition, state-level blue sky laws might require lock-up agreements, depending on the state.
What is the Purpose of an IPO Lock-up Period?
After a company's stock enters the market, the lock-up period for freshly issued public shares aids in stabilizing the stock price. The business makes more money when the price and demand of the stock are higher.
Stock prices and demand would decrease if company executives sold their shares to the general public, giving the impression that the company is not worth investing in.
Key employees may receive shares of stock instead of cash compensation when a privately held business starts the process of going public. However, after the business goes public, many employees might want to sell their shares as soon as possible.
The lock-up time stops the stock from being sold right away after the IPO when share prices might be unnaturally high and subject to high price volatility.
Note
A business typically makes more money when stock prices and demand are higher.
Many important employees typically want to sell their stock as soon as feasible when a private company goes public.
Therefore, the primary goal of an IPO lock-up period is to avoid oversaturation of the market with shares, which will drive down the stock price.
The lock-up period is crucial because significant stock sales by company insiders could create the impression that they lack faith in the company's future. After the lock-up time has ended, a company's stock price frequently declines permanently.
Sometimes, even after the lock-up period has passed, company insiders are unable to sell their shares because doing so would be deemed insider trading because they have significant access to information that is not generally known.
A comparable scenario might occur if the lock-up's expiration coincides with earnings season.
Example of a Lock-Up Period
Here’s a more detailed example:
Suppose some hedge fund deals in troubled Central American debt.
Even though interest rates are elevated, there is little market liquidity. As a result, prices would drop much more quickly if one of the hedge fund’s clients tried to sell a sizable chunk of their assets all at once rather than the hedge fund selling smaller chunks over time.
However, because this hedge fund has a 90-day lock-up period, they have more time to sell their securities progressively, which allows the market to absorb the sales more evenly and maintain prices more steadily.
As a result, the investor and hedge fund fare better than they might have otherwise.
Lock-up Period FAQs
A lock-up period is a predetermined time following an initial public offering (IPO). During this period, company insiders, investors, and employees are not permitted to sell or redeem their shares.
The length of a lock-up period can vary based on the business and the particulars of its IPO. Following the IPO, the lockup period can last 30 to 90 days or 90 to 180 days.
No, the whole point of a lock-up period is to prevent shares from being sold once the company goes public. The only exception is selling shares to settle tax debts or other legal purposes.
Although rare, lock-up times may be extended or shortened in certain circumstances. Typically, this is done to respond to the needs of insiders who may need to sell their shares for legitimate reasons or to adjust to changing market circumstances.
It is only possible to settle tax debts or for other legal purposes.
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