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Lock-up Period

The predetermined time frame in which corporate insiders, investors, and employees cannot redeem or sell their shares (after an IPO)

What is the Lock-up Period?

A lock-up period, also called a locked-up, lock-in or lock-out period, refers to the predetermined time frame in which corporate insiders, investors, and employees are not allowed to sell or redeem their shares after an initial public offering (IPO). It normally happens in instances where a private entity offers its initial stock issuance in order to turn into a publicly traded corporation.

 

Lock-up Period

 

The management, as well as the large stockholders of a publicly-traded company, such as investors and company executives that represent a large portion of company ownership, are forbidden to sell their shares following an IPO for a given period of time.

The law usually does not oblige businesses that want to go public to follow a lock-up period. The lock-up period is normally something that the individual companies and/or the investment banks underwriting the IPO request to keep the price of the company’s stock up.

 

How Long is a Lock-up Period?

The lock-up period usually takes 90–180 days, depending on the company, before the shareholders can be are allowed to exercise the option. Even though lockups used to be fairly simple – typically lasting 180 days for everybody –  they are gradually becoming more complex.

Investors and employees usually want lockups that are shorter so that they can cash out earlier while underwriting banks often want lockups that are longer to prevent insiders from saturating the market and dropping the share price. The company is usually somewhere in the middle since they want to ensure that the investors and employees are happy but do not want it to seem like insiders lack enough faith in it.

 

What is the Purpose of an IPO Lock-up Period?

A company usually brings in more money when the price and demand for the stock are up. When a private entity begins the process of going public, many key employees usually want to cash in their shares of company stock as quickly as possible. The main purpose of putting an IPO lock-up period place is to inhibit the flooding of the market with too many shares, which will lower the stock’s price due to insiders’ selling activities after the IPO.

The lock-up period is also important because large stock sales by people close to the company may give the impression of a lack of confidence in its prospects, even when business insiders just want to cash in long-projected profits, which may trigger a panic sell. It is common for the stock price of a company to go down permanently after the end of the lock-up period and for its volume of trading to increase considerably.

At times, corporate insiders can’t sell their shares even after the expiry of the lock-up period because they possess substantial, nonpublic information and, therefore, a sale would be considered as insider trading. A similar scenario may occur, for instance, if the expiry of the lock-up corresponded with earnings season.

 

Key Takeaways

An IPO lock-up period is a contractual constraint that inhibits business insiders that are holding company stock, before the company goes public, from selling their stock for a period typically taking 90 -180 days (depending on the company) after the company’s gone public. Such Insiders may include company owners, founders, employees, managers and venture capitalists.

The purpose of lockups is to stop corporate insiders from hastily liquidating assets after the company’s IPO. it helps in ensuring that the market will not inexplicably increase the supply of shares, which drives prices downward.

The lock-up period for freshly issued public shares helps to stabilize the price of the stock on entering the market. When corporate insiders sell their shares in the company to the public, it appears that the organization is not worth investing in, causing the prices and demand of stock to go down.

 

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Investing: A Beginner’s Guide
  • Irrevocable Proxy
  • Sale and Purchase Agreement
  • Voting Trust

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