What is a Lock-Up Period?

It is a period of time when the management and large shareholders of a publicly traded company are not allowed to sell their shares in the market. Usually following the initial public offering (IPO), the company management and investors are restricted to sell their shares. The same is also known as a lock-in, lock-out or locked up period.

The lock-up period may also be applicable to the shareholders who acquire the stocks during the IPO. A lock-up period may stay for as long as 90 days to 180 days depending on the company. The companies specify a lock period to ensure that the market is not over flooded with the company's share at any given point of time. It is to prevent a dramatical price drop of the stocks of the company. 

How does a Lock Up Period Work? 

Private companies can go public by selling their stocks to the general public, this is known as the initial public offering. In order to be listed on an exchange, a company needs to go public with their stocks. It may be a newly formed company or an old company that wants to sell their stocks to the general public to raise capital. During the initial public offering a company can issue new shares to the public or the existing shareholders can sell their stocks to the general public. 

The lock-up period restricts the existing shareholders from liquidating their assets too quickly after the initial public offering. Large shareholders selling their stocks can also be perceived as a lack of confidence in the company and that may lead to panic sell. Lockup period may apply to someone who has acquired a company's shares in an initial public offering or to the early investors and employee of the company who hold the company's shares. 

Usually, the early investors and employees prefer a shorter lock-up period and underwriting banks want a longer one.In earlier days, lockup periods were usually 180 days for everyone but now the rules have become increasingly complex. The lock-up period for hedge funds depends on the underlying investments of each fund. It is usually a 90 days period for the funds invested in liquid stocks. The hedge funds invested in securities like loans or other debts may have a longer lock-up period. There may be no lock-up period for certain other hedge funds based on its nature of the investment.

When the lock-up gets over, the shareholders are allowed to sell their shares according to the rule. Generally, they need to notify the fund manager 30 to 90 days prior to the redemption so that the manager can arrange the payments of the investors.The lock-up period allows the hedge manager to utilize the funds in a more efficient manner. During the lock-up period, the manager does not require to worry about share redemption and he/she may invest in securities according to the need. 

In this way, the manager is able to invest in assets and maximize potential gains without keeping much cash in hand. If there was no lock-up period, the hedge manager would have to be ready all the time with a large amount of cash or cash equivalents to pay the investors. It that case the manager could invest less amount of money with a lower return. As the lock-up period depends on the investors personal investment date, a huge liquidation does not occur for a fund at once. It allows the company to stabilize its funds effectively.

 After a company enters the market it needs some time to stabilize its stock price. The lock-up period allows that time, without a lock-up period in place if the shareholders start liquidating their stocks too fast that would negatively affect the company's stock prices.