A lock-up period is a contractual agreement often used during initial public offerings (IPOs) to prevent inside investors from selling their shares immediately after a company goes public. These lock-up periods can reduce volatility after an IPO and give the market a chance to level off.
Before investing in a company that’s still under a lock-up period, it’s important to understand how it could affect you. Learn how lock-up periods work, their pros and cons, and what you need to be aware of as an individual investor.
Definition and Examples of a Lock-Up Period
A lock-up period is a time frame during which inside investors are prohibited from selling their shares in a company. Lock-up periods are often required in the case of an IPO to ensure company insiders don’t enter the public market immediately after the company goes public.
A recent example of when a lock-up period was used was in the case of Airbnb’s IPO in December 2020, selling 50,000,000 shares of Class A stock at $68 per share. The IPO included a lock-up period of 180 days, which expired on June 8, 2021.
Investment banks that underwrite IPOs typically require a lock-up of at least 180 days from key shareholders.
Alternate name: Lock-up agreement
How Lock-Up Periods Work
When a company issues an IPO, it offers shares of ownership to public investors for the first time. But even after the IPO, corporate insiders continue to earn a percentage of ownership. A large percentage of individual insiders own stock in Airbnb, for example.
Inside investors usually purchase their shares at a price that’s significantly lower than the IPO price. As a result, they have an incentive to sell their shares after an IPO, which could affect the IPO’s success.
Because of that, when a company goes public, the investment banks that underwrite the IPO typically require a contractual lock-up period. During that time, inside investors can’t sell their shares or are limited as to the number of shares they can sell. The purpose of the lock-up period from the perspective of the underwriter is to allow the market to develop for a while.
Lock-up periods are also sometimes required under state law, known as “blue sky” laws. These laws are specifically focused on the regulation of the sale of securities, protecting investors against nefarious activity on the part of corporations, brokerage firms, and more.
Pros and Cons of a Lock-Up Period
Reduces initial volatility
Doesn’t apply to individual investors
Can end with a drop in the share price
Reduced liquidity for inside investors
- Reduces initial volatility: The reason underwriters often insist on these lock-up periods is that it gives the market time to gain some stability before inside investors sell their shares. If they all were to sell immediately after the IPO, there could be increased volatility that would harm the stock price and the IPO’s success.
- Doesn’t apply to individual investors: As an individual investor, you won’t see your liquidity affected by lock-up periods. They generally only apply to inside investors such as employees, executives, venture capitalists, and other insiders.
- Can end with a drop in the share price: A company’s stock price often declines when its lock-up period expires. It could be either a result of the flood of shares being sold or even just the anticipation of it. As a result, individual shareholders could see their shares lose value.
- Reduced liquidity for inside investors: Lock-up periods reduce investment liquidity for inside investors since they aren’t able to sell their shares for 180 days. In many cases, these inside investors are company executives and founders. However, they could also be employees who received the shares as part of their compensation.
What It Means for Individual Investors
As an individual investor, you’re unlikely to be prevented from selling your shares during a lock-up period unless you work for the company and received shares as compensation. That being said, you can still be affected by a company’s lock-up period in the long run.
Often, a company’s stock price dips at the end of a lock-up period. Because of this, the Securities and Exchange Commission (SEC) recommends investors research a company’s lock-up period before investing. If the company is still in a lock-up period, you might decide to wait until it expires to invest. Not only could you take advantage of a potential price dip, but you would avoid losing money owning a stock that loses value.
- A lock-up period is a time frame of usually 180 days after an IPO during which inside investors are prohibited from selling their shares.
- Investment banks that underwrite IPOs often require lock-up periods to reduce volatility immediately after an IPO and give the market a chance to gain some stability.
- Lock-up periods don’t apply to individual investors; they usually only apply to insiders such as founders, executives, employees, friends, family, and venture capitalists.
- A company’s stock price may see a dip when its lock-up period expires as more people are able to sell off their shares.