Lock-up agreement definition
/What is a Lock-Up Agreement?
A lock-up agreement is a legal provision that blocks company insiders from selling their shares. This agreement is usually enforced as part of an initial public offering (IPO), and expires anywhere from three to 12 months later. A summarization of all lock-up agreements is included in the prospectus that is issued to the investment community as part of the run-up to an IPO.
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Understanding Lock-Up Agreements
A lock-up agreement is intended to reduce the amount of selling pressure on a company’s stock during its first few months of trading. Insiders will likely want to sell their shares and realize significant gains by doing so, which typically results in heavy stock sales during the months immediately following an IPO. The pressure to sell is increased even more by the presence of employee stock options, since the exercise price of these options is likely below the price at which the shares will be trading immediately after the IPO. The use of these agreements is good for the general investor, who might otherwise be faced with a situation where company insiders overstate the prospects of the business in order to inflate its stock price, and then sell all of their shares to maximize their profits, leaving a sharp stock price decline for others to deal with.
Duration of a Lock-Up Agreement
The lock-up period may vary by class of insider; for example, senior management might be required to wait 12 months, while early-round investors can sell their shares after three months. Once these lock-up periods expire, it is possible that the stock price will decline significantly, since a large supply of stock will then be dumped on the market.