What Is a Lock-Up Period? How They Work, Main Uses, and Example

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

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. This feature may be in place to protect other investors, preserve market integrity, or make sure certain securities are liquid.

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.

How a Lock-Up Period Works for Hedge Funds

The lock-up period for hedge funds corresponds with the underlying investments of each fund. For example, a long/short fund invested 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.

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.

Hedge Fund Lock-Up vs. Start-Up Lock-Up

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.

Benefits to IPO Lock-Up

There are a few reasons investors, companies, and regulatory bodies want lock-up periods. If you're wondering why lock-up periods exist, it's because a lock-up period theoretically:

• Stabilizes Stock Prices Post-IPO: Lockup periods help stabilize stock prices following an IPO by preventing insiders from selling their shares immediately. This stabilization helps prevent drastic price drops due to sudden, large-scale sales.
• Provides Time for Market Stabilization: The lockup period allows time for the market to absorb and adjust to the new stock offering. It provides a buffer for the stock to find its equilibrium without being overly influenced by large insider transactions.
• Aligns Insiders’ Interests with Long-Term Success: By restricting insiders from selling their shares immediately, lockup periods align the investor's interests (i.e. long-term) with the long-term success of the company. Insiders are incentivized to focus on the company’s growth and performance, knowing that they cannot realize any gains from their shares until the lockup period ends.
• Encourages a Stable Transition to Public Markets: For companies going public, lockup periods facilitate a stable transition from private to public markets. The gradual release of shares helps avoid market disruptions and provides time for the company to establish itself in the public domain.
• Helps Manage Supply and Demand Dynamics: Lockup periods assist in managing the supply and demand dynamics of the stock. By restricting the supply of shares available for trading, lockup periods help prevent an oversupply (that could depress the stock price).

Exemptions of a IPO Lock-Up Period

Exceptions and early releases from lockup periods can occur under specific circumstances. One common scenario is when a company faces an urgent financial need or strategic opportunity that necessitates an early release. For example, a company might need to raise additional capital quickly for expansion or acquisition purposes. In such cases, the company may negotiate with underwriters or regulatory bodies to allow early sales of shares by insiders to address immediate financial requirements.

Another reason for early release is to accommodate changes in market conditions or investor sentiment. If a lockup period coincides with a downturn in the market, insiders may seek an early exit to mitigate potential losses. Companies may, in hopes of earning goodwill with those investors, extend to them selling opportunities in hopes of securing additional funding in the future. Regulators or underwriters might permit early release if they believe it will benefit the broad market as well.

Certain legal or contractual obligations can also lead to early release from lockup periods. For instance, some pre-existing agreements or commitments may require insiders to liquidate their holdings for personal or legal reasons.

Most retail investors are not tied into lock-up periods. Aside from unfavorable tax consequences or wash sale implications, many investors can simply buy and sell stocks as they choose.

Downsides of Lock-Up Periods

There are some obvious downsides to lockup periods that have been briefly touched on throughout this article. To summarize those downsides, the list below are unfavorable reasons companies or investors may not want lock-up periods:

• Potential for Increased Volatility Post-Lockup: Lockup periods can lead to significant stock price volatility once they expire. When insiders are finally allowed to sell their shares, the sudden influx of supply can flood the market and drive down the stock price.
• Market Uncertainty and Speculation: Even if people don't sell when the lock-up period ends, the anticipation of the lockup period’s expiration can create uncertainty and speculation in the market. Investors might speculate on the potential actions of insiders which can affect stock prices and trading volume (even if not a single locked-up stock is ever sold).
• Potential for Negative Perception: When insiders sell their shares immediately after the lockup period, it can be perceived negatively by the market. Investors might interpret these sales as a lack of confidence in the company's future prospects.
• Restrictions on Insiders' Liquidity: During the lockup period, insiders are restricted from accessing the liquidity of their shares. This lack of liquidity can be a disadvantage if insiders need to sell their shares for personal financial reasons.

Example of a Lock-Up Period

On July 26, 2024, WeRide Inc. filed a Form F-1 with the Securities and Exchange Commission. The form was filed with the SEC as part of WeRide's IPO.

As part of the IPO, WeRide extended share offerings to directors and executive officers. Those shares were offered with a lock-up agreement where nobody would be allowed to "offer, sell, contract to sell, pledge, grant any option to purchase, make any short sale", or perform other actions. The full language from Form F-1 is below.

What Is a Lock-Up Period?

A lock-up period is a predetermined time frame during which holders of shares of stock are restricted from selling their shares. This happens in several contexts including hedge funds or IPOs.

How Does a Lock-Up Period Work?

For IPOs, during a lock-up period, insiders are legally prohibited from selling or transferring their shares. This restriction is typically agreed upon between the company and underwriters during the IPO process. The period usually lasts between 90 to 180 days, although it can vary. Once the lock-up period ends, insiders are free to sell their shares, which can potentially impact the stock price due to increased supply.

How Can Lock-Up Periods Affect Stock Prices?

Lock-up periods can significantly affect stock prices. When the lock-up period expires, the release of a large number of shares by insiders can lead to increased supply in the market, which might drive down the stock price.

Can Companies Extend or Shorten a Lock-Up Period?

Companies generally cannot extend or shorten a lock-up period unilaterally. Any changes to the lock-up period require approval from the underwriters and may involve renegotiating terms with investors.

The Bottom Line

A lock-up period is a designated time (usually following an IPO) during which company insiders are prohibited from selling their shares. The period aims at stabilizing stock prices and preventing market volatility. Once the lock-up period expires, insiders can sell their shares, potentially leading to increased market activity and price fluctuations.