A lock-up period is a predetermined window of time following an initial public offering (IPO) when company insiders and major shareholders are prohibited from selling their shares.
Understanding lock-up periods
When a company goes public, underwriters and company executives agree to a lock-up period to stabilize the stock price. If insiders sell all their shares immediately upon listing, the sudden increase in supply can cause the share price to drop. This restriction ensures that the people who know the company best remain invested during the early months of public trading.
The length of a lock-up period varies by market and specific underwriter agreements. Globally, these periods typically range from 90 to 180 days. Some regulatory bodies mandate longer lock-ups for certain types of shares or specific tiers of exchanges. The contract is signed between the underwriters and the insiders, meaning it is a private binding agreement rather than a statutory law in most jurisdictions, though some countries do enforce statutory lock-ups for specific listings.
Fellow Elephants trading in newly public companies often monitor the stock closely as the expiration date approaches. Once the lock-up period expires, a large volume of restricted shares becomes available for trading. This event can lead to increased volatility and downward pressure on the stock price if many insiders decide to sell their holdings at the same time. Market participants factor this expiration date into their trading strategies to anticipate potential price movements.
Example
Consider an agricultural firm named Savannah Peanuts that recently completed its initial public offering. The founders, a family of elephants, own 60 percent of the outstanding shares. To prevent a sudden market crash on opening day, the underwriters require the elephants to sign a 180-day lock-up agreement. For the first six months of public trading, the elephants cannot sell their equity on the open market. On day 181, the lock-up period expires, and the elephants are free to liquidate portions of their holdings to fund new foraging operations. Retail investors watching Savannah Peanuts track this specific date, anticipating potential price drops if the herd decides to sell a large volume of stock at once.