how lock up agreements work
lock up periods typically last 180 days but on occasion can be as brief as 90 days or as long as one year sometimes all insiders will be locked out for the same period of time in other cases the agreement will have a staggered lock up structure in which different classes of insiders are locked out for different periods of time although federal law does not require companies to employ lock up periods they may nevertheless be required under states blue sky laws 1the details of a company s lock up agreements are always disclosed in the prospectus documents for the company in question these can be secured either by contacting the company s investor relations department or by using the securities and exchanges commission s sec electronic data gathering analysis and retrieval edgar database the purpose of a lock up agreement is to prevent company insiders from dumping their shares on new investors in the weeks and months following an ipo some of these insiders may be early investors such as vc firms who bought into the company when it was worth significantly less than its ipo value therefore they may have a strong incentive to sell their shares and realize a gain on their initial investment similarly company executives and certain employees may have been given stock options as part of their employment agreements as in the case of vcs these employees may be tempted to exercise their options and sell their shares as the company s ipo price would almost certainly be far above the exercise price of their options special considerationsfrom a regulatory perspective lock up agreements are meant to help protect investors the scenario that the lock up agreement is meant to avoid is a group of insiders taking an overvalued company public then dumping it on investors while running away with the proceeds this was a real issue during several periods of market exuberance in the united states and is the reason why some blue sky laws still have lock ups as a legal requirement even when a lock up agreement is in place investors that are not insiders to the company can still be affected once that lock up agreement runs past its expiration date when lock ups expire company insiders are permitted to sell their stock if many of the insiders and vcs are looking to exit this can result in a drastic drop in the share price due to the huge increase in the supply of the stock of course an investor can look at this in two ways depending on their perception of the quality of the underlying company the post lock up drop if it indeed occurs can be an opportunity to buy shares at a temporarily depressed price on the other hand it can be the first sign that the ipo was overpriced signaling the start of a long term decline example of a lock up agreementstudies have shown that the expiration of a lock up agreement is generally followed by a period of abnormal returns unfortunately for investors these abnormal returns are more often in the negative direction interestingly enough some of these studies found that staggered lock up agreements can actually impact a stock more negatively than those with a single expiration date this is surprising as staggered lock up agreements are often seen as a solution to the post lock up dip 