What is a Lock-Up Period?
A lock-up period is a window of time when investors are not allowed to redeem or sell shares of a particular investment. There are two main uses for lock-up periods, those for hedge funds and those for start-ups/IPO’s.
For hedge funds, the lock-up period is intended to give the hedge fund manager time to exit investments that may be illiquid or otherwise unbalance their portfolio of investments too rapidly. Hedge fund lock-ups are typically 30-90 days, giving the hedge fund manager time to exit investments without driving prices against their overall portfolio.
For start-ups, or companies looking to go public through an IPO, lock-periods help show that company leadership remains intact and that the business model remains on solid footing. It also allows the IPO issuer to retain more cash for continuing growth.
How a Lock-Up Period Works
The lock-up period forhedge fundscorresponds with the underlying investments of each fund. For example, along/shortfundinvested mostly in liquid stocks may have a one-month lock-up period. However, because event-driven or hedge funds often invest in more thinly traded securities like distressed loans or other debt, they tend to have prolonged lock-up periods. Still, other hedge funds may have no lockup period at all depending on the structure of the fund's investments.
When the lock-up period ends, investors may redeem their shares according to a set schedule, often quarterly. They normally must give a 30- to 90-day notice so that the fund manager may liquidate underlying securities that allow for payment to the investors.
Key Takeaways
- Lock-up periods are when investors cannot sell particular shares or securities.
- Lock-up periods are used to preserve liquidity and maintain market stability.
- Hedge fund managers use them to maintain portfolio stability and liquidity.
- Start-ups/IPO’s use them to retain cash and show market resilience.
During the lock-up period, a hedge fund manager may invest in securities according to the fund’s goals without concern for share redemption. The manager has time for building strong positions in various assets and maximizing potential gains while keeping less cash on hand. In the absence of a lock-up period and scheduled redemption schedule, a hedge fund manager would need a great amount of cash or cash equivalents available at all times. Less money would be invested, and returns may be lower. Also, because each investor’s lock-up period varies by his personal investment date, massive liquidation cannot take place for any given fund at one time.
Lock-up periods can also be used to retain key employees, where stock awards are not redeemable for a certain period to keep an employee from moving to a competitor, maintain continuity, or until they have completed a key mission.
Example of a Lock-Up Period
As an example, a fictitious hedge fund, Epsilon & Co., invests in distressed South American debt. The interest returns are high, but the market liquidity is low. If one of Epsilon’s customers sought to sell a large portion of its portfolio in Epsilon at one time, it would likely send prices far lower than if Epsilon sold portions of its holdings over a longer period of time. But since Epsilon has a 90-day lock-up period, it gives them time to sell more gradually, allowing the market to absorb the sales more evenly and keep prices more stable, resulting in a better outcome for the investor and Epsilon than may otherwise have been the case.
Special Considerations
The lock-up period for newly issued public shares of a company helps stabilize the stock price after it enters the market. When the stock’s price and demand are up, the company brings in more money. If business insiders sold their shares to the public, it would appear the business is not worth investing in, and stock prices and demand would go down.
When a privately held company begins the process of going public, key employees may received reduced cash compensation in exchange for shares of the company's stock. Many of these employees may want to cash in their shares as quickly as possible after the company goes public. The lock-up period prevents stock from being sold immediately after theIPOwhen share prices may be artificially highand susceptible to extreme price volatility.
FAQs
Lock-up periods are when investors cannot sell particular shares or securities. Lock-up periods are used to preserve liquidity and maintain market stability. Hedge fund managers use them to maintain portfolio stability and liquidity. Start-ups/IPO's use them to retain cash and show market resilience.
What is the purpose of lock ups? ›
The purpose of lockups is to stop corporate insiders from hastily liquidating assets after the company's IPO. It helps ensure that the stock price will not decline from a sudden flood of selling. The lock-up period for freshly issued public shares helps stabilize the price of the stock on entering the market.
What is lock in period and lock-up period? ›
A lock-up period, also known as a lock in, lock out, or locked up period, is a predetermined amount of time following an initial public offering where large shareholders, such as company executives and investors representing considerable ownership, are restricted from selling their shares.
What is lock in period for companies? ›
The lock in period for an IPO is usually set at six months. However, it can be extended to 1 year. During this period an investor is not allowed to sell their shares. The purpose of a lock in period is to stabilise a company's share price before its investors can cash out.
What is the meaning of lock up days? ›
Your lock up days is the number of days it takes to convert your debtors, stock and work in progress into cash. The higher your lock up days, the more cash is needed in the business (either from you or the bank), and the higher the risk of losing that cash.
What happens after lock-up period? ›
Because of the flood of shares hitting the market, the supply can exceed the demand when the lock-up period expires, forcing down the price. Additionally, people now expect this to happen and will pre-empt this selling with their own.
How long is the lock-up period? ›
An IPO lock-up is a period after a company has gone public when major shareholders are prohibited from selling their shares, and typically lasts 90 to 180 days after the IPO.
What happens after lock in period? ›
You need to keep in mind that once the lock-in period of your ELSS or any other scheme expires, the fund becomes an open-ended scheme. Once this happens, you can withdraw money from your scheme at any point of time. You also do not have to pay any exit load or any tax for such withdrawals.
What is lock in period disadvantages? ›
The lock-in period has many benefits, such as commitment, promoting long-term investing, discouraging impulsive exits, and ensuring wealth generation. 2. What are the lock-in period disadvantages? The lock-in period restricts investors from changing their investments in case of emergency fund requirements.
What is an example of lock up? ›
lock somethingup
to make a building safe by locking the doors and windows Don't forget to lock up at night. He locked up the shop and went home.
to lock or secure the doors, windows, etc, of (a building) tr to keep or store securely.
How to improve lock up days? ›
How to reduce lockup and improve cash flow
- Understand your data and set targets. The first step to improving lockup is to understand your own data, set clear targets and monitor performance. ...
- Change business practices. ...
- Use technology. ...
- Offer flexible payment options.
The purpose of a lock-up agreement is to prevent company insiders from dumping their shares on new investors in the weeks and months following an IPO. Some of these insiders may be early investors such as VC firms, who bought into the company when it was worth significantly less than its IPO value.
What is the purpose of a lockup provision quizlet? ›
prevent downward pressure on the stock's price. The purpose of a lockup provision is to: A) keep individual investors from buying and selling stock.
What is the importance of locks in security? ›
Locks are the most acceptable and widely used security devices for protecting facilities, materials and property. All containers, rooms, and facilities must be locked when not in actual use. Regardless of their quality or cost, locks are considered delay devices only.
What happens when a stock lockup expires? ›
A lockup period is a contract that states there is a period after a company goes public when the major shareholders are not allowed to sell their shares. The lockup usually lasts between 90 and 180 days. When this period ends, the trading restrictions get removed.
