A lock-up agreement is a legal agreement signed by all the shareholders of a company, which restricts them from selling any shares of the company’s stock for an agreed period of time. This agreement is signed by all the shareholders of the company including executives, directors, managers etc. A lock-up agreement is normally signed during an initial public offering of the company. The agreement makes sure that the prices of company stocks are stable during the first few months. The restricted stakeholders are allowed to sell the stocks after the duration of lock-up agreement is over.
Duration of Lock-Up Agreement:
The duration of a lock up agreement is usually six months but could also be a minimum of three months or a maximum of twelve months. Since there are no federal laws about the duration of a lock-up agreement, the decision is normally made by the underwriter.
Purpose of Lock-Up Agreement:
The main purposes of a lock-up agreement are:
- To ensure stable trading during and after the IPO.
- To align the company goals with the incentives of insiders.
- To prevent opportunistic behavior of insiders that could cause selling of shares at lower price.
Therefore, a lock up agreement between the insiders and underwriters ensures that stock prices remain stable and the public offering of the company goes smoothly. It is important to keep in mind that float is of great significance during an IPO. Float is the number of shares still available for public trading i.e. not locked by the lockup agreement. Small float is subjected to greater volatility as an entity with large order of shares can decide to sell and thus influence the stock price once the lock-up agreement expires. Larger float ensures that stock is less volatile.
How Lock-Up Agreement Affects The Investors:
There are laws in place that require the company that has recently undergone IPO, and is under a lock-up agreement, to reveal the terms of agreement in their registration forms and prospectus. These laws make sure that the company doesn’t take any undue advantage of the investors or public shareholders. Additional clauses in lock-up agreement could also restrict the number of shares sold in a particular duration after the lock up agreement expires. These clauses also prevent the drastic drop that might occur in the price of shares when the lock-up agreement expires. Investors should be aware before investing, of whether the company is under a lock-up agreement, because there’s a good chance of a drop in stock prices when the lock-up agreement expires.