What Does Lock-Up Agreement Mean?
A lock-up agreement is a provision or a clause agreed on between underwriters and insiders of the firm going public with an initial public offering (IPO). It prohibits insiders from selling their stake in the firm for a specified duration from the date of the closure of the IPO. In some cases, the agreement may only limit the number of shares the insiders are allowed to sell during the prescribed period. The clause could also be a part of an agreement offer for the sale of the majority stake in a company, binding the new buyer to not resell the stake or the assets for a specified duration of time.
This agreement is significant because it tries to stabilize the price of the stock for a specified period as well as ensure that insiders, in case of an IPO, and the acquirer, in the case of a sale of a controlling stake, continue to act in line with the goals of the firm, allowing time for the market to discover the true worth of the stock in a stable market.
Divestopedia Explains Lock-Up Agreement
In most IPOs, the lock-up is sought for 120 to 365 days. It is meant to disable insiders from opportunistically selling off their holdings, since they know that the firm is over-valued on account of perceptions created due to some window dressing during road shows.
Investors who are planning to hold their shares or invest afresh in the company after an IPO is closed must find out when the lock-up period is going to end, as insiders may be tempted to sell part of their holdings, causing selling pressure in the market for the stock.
The lockup agreement is required to ensure that IPO subscribers are not put at a disadvantage by insiders. These subscribers could be owners, executives, employees, venture capitalists or their family members.
In the case of the sale of a controlling stake, the acquirer is sometimes required to agree to a lock-up clause that prohibits the resale of the stake or assets during the agreed lock-up period. This is to ensure price stability for other stakeholders. This route is sometimes explored by companies facing hostile takeovers.