Lock-up agreements: Overview, definition, and example
What are lock-up agreements?
A lock-up agreement is a period following an initial public offering (IPO) or a private placement during which major shareholders (such as company executives, employees, or insiders) are prohibited from selling their shares. The lock-up period is designed to prevent a flood of shares from hitting the market immediately after the IPO, which could potentially destabilize the stock price. Lock-up agreements are typically negotiated between the company and its underwriters, and the duration of the lock-up period can vary, commonly lasting from 90 to 180 days.
For example, after a company goes public, its executives may not be able to sell their shares until the lock-up period expires, ensuring that the market is not overwhelmed by selling pressure in the early days of the company’s public trading.
Why are lock-up agreements important?
Lock-up agreements are important because they help maintain market stability after a company’s IPO or private placement. By preventing large amounts of stock from being sold immediately, the lock-up period ensures that the company’s stock price is not artificially depressed by excess supply. For businesses, lock-up agreements help build investor confidence and give the market time to absorb the initial offering. For investors, the lock-up period provides some assurance that insiders will not sell off their shares and undermine the stock’s value in the short term.
For companies, understanding the terms of lock-up agreements is critical for managing market perception and preparing for the post-IPO period. The lock-up period also provides time for the company to prove its value in the market.
Understanding lock-up agreements through an example
Imagine a technology company that is preparing for an IPO. The company and its underwriters agree to a 180-day lock-up period for company executives and early investors. This means that after the company goes public, executives and early investors are not allowed to sell their shares for six months. This prevents a large sell-off of shares that could negatively impact the stock price. After the lock-up period ends, these insiders are free to sell their shares in the open market.
In another example, a pharmaceutical company’s stock price surges after its IPO due to investor excitement about its pipeline. However, major insiders are unable to sell their shares until the lock-up period expires, which helps ensure the stock price remains stable as it is supported by long-term investors rather than insider selling.
An example of a lock-up agreement clause
Here’s how a lock-up agreement clause might look in an IPO agreement:
“The Company agrees that, for a period of 180 days following the effective date of the Registration Statement, no shareholder of the Company who owns [Insert Percentage] or more of the Company’s shares shall directly or indirectly sell, transfer, or otherwise dispose of any shares of the Company, except as otherwise provided in this Agreement.”
Conclusion
Lock-up agreements are essential in ensuring the stability of a company’s stock price following its IPO or private placement. By preventing insiders from selling their shares too soon, lock-up agreements help create a more controlled and stable market environment for the new public company.
For businesses, understanding the purpose and terms of lock-up agreements is critical for managing the post-IPO period and maintaining investor confidence. For investors, lock-up agreements provide assurance that insider selling will not overwhelm the market in the early days of a company’s public trading.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.