What is a Lock-Up Agreement?

A lock-up agreement is a contract that prohibits people who are considered insiders within a particular corporation from selling their shares of stock in that business for a specific period of time. While this type of agreement may be invoked under several different scenarios, the event of an initial public offering, or IPO, is one of the more common. Generally, all executives, managers, and other employees who are granted shares of stock are asked to sign an agreement of this kind, along with any venture capitalists or underwriters associated with the business.

The idea behind a lock-up agreement is to prevent the price per share associated with the company stock from becoming unstable during the time frame specified within the contract. Doing so helps to minimize the chances of people using the data they receive as part of their normal interactions with the business, and attempting to trade those shares based on that insider information. Taking this precaution to prevent trades based on data that is not readily available to other investors is very important, since a sudden glut of shares dumped into the marketplace would arouse caution among the investment community. In turn, demand for the shares would decrease and the price per share would also drop.

Making use of a lock-up agreement as a means of discouraging a takeover attempt is also a relatively common application. By imposing a time frame in which officers and other key participants in the company may not sell their shares, the business buys valuable time that can be used to develop a strategy to counter the takeover attempt. At the same time, the approach may be used to reduce the number of entities attempting to acquire the business, while paving the way for purchase by an entity that the company officers feel provides the most attractive offer. When used in this manner, the process is sometimes referred to as a crown jewel lock-up agreement.

The duration of a lock-up agreement will depend on several factors. Among these is the purpose for the lock-up. For an IPO, the agreement may prohibit the sale of shares for anywhere from a couple of months to one year, based on when the initial pubic offering is slated to take place. On average, the contract will cover a six-month period that extends into the first months after the public offering occurs, a move that helps to limit the volatility of the shares and give the stock a chance to perform well in the marketplace.