What is a Lock-Up Agreement?

A lock-up agreement is an agreement between company insiders and an underwriting firm that stipulates that company insiders must not sell their shares of the company's stock for a specific period. The insiders of a company are employees, directors and senior officers of the company who own over 10% of the company's shares. 

In a lock-up agreement, company insiders are prohibited from selling their shares during the lock-up period (a specified period of time). The lock-up period for most underwriters is six months which is 180 days. Some underwriters, however, go below or beyond this benchmark and can have a lock-up period of 120 days or a full year.

How does a Lock-Up Agreement Work?

Lock-up agreements are often used by underwriters during an initial public offering. This agreement is a legal contract between underwriters and the insiders of a company that clearly states that the insiders must no sell their shares of a company's stock within the stipulated time. Lock-up agreements are reached when there is a need to stabilize the stock of a company. 

However, in certain cases, a lock-up agreement might allow company insiders to sell a specific part of their holdings in the company's stock after the IPO, but most lock-up agreements disallow insiders from selling the shares of the stock. Lock-up agreements are reached to avoid a collapse in the value of a company's stock.

Why Lock-Up Agreements Matter to Investors

Lock-up agreements are important to investors because it safeguards their investment in a company by prohibiting an abrupt dilution of the stock of a company. Another benefit of lock-up agreements to intending investors of a company is that it protects them from buying the shares of a company that is unstable. 

For instance, the insiders of a company who have access to high-ended information about a company might want o sell their shares of a company once they notice volatility. Unknown to investors, they might buy the shares while the insiders cart away with their profits leaving the investors to bear the grunts. Hence, with the provision of lock-up agreements, intending investors know the status of a company if a lock-up agreement is in existence.

Lock-Up Agreement Expiration and Stock Prices

All lock-up agreements have expiration dates that might positively or negatively affect stock prices. Investors often look out for the impact that lock-up agreement expiration have on stock prices. For instance, in a scenario where many insiders of a company who were earlier restricted from selling their shares of stock want to exit the company after the lock-up agreement has expired, it can cause a collapse or decline in stock price and value. 

In a situation like this, investors can deduce whether the shares of the underlying company are worth buying or not. While the lock-up agreements expiration period seems to be an opportunity for investors to acquire the stock of a company at a reduced price, it could also be dicey. Many studies have found out that post-lock-up periods tend to affect the stock of a company negatively as this period is when most companies have low returns on their new issues.