What is a 'Lock-Up Period'
A lock-up period is a window of time when investors of a hedge fund or another closely held investment vehicle are not allowed to redeem or sell shares. The lock-up period helps portfolio managers avoid liquidity problems while capital is put to work in sometimes illiquid investments.
The initial public offering (IPO) lock-up is a common lock-up period in the equities market used for newly issued public shares, typically lasting anywhere from 90 to 180 days after the first day of trading, so fund managers can keep a lower amount of cash on hand.
BREAKING DOWN 'Lock-Up Period'The lock-up period for hedge funds correlates with the underlying investments of each fund. For example, a long/short fund invested mostly in liquid stocks may have a three-month lock-up period. Because event-driven or distressed hedge funds often invest in more thinly traded securities like loans or other debt, they tend to have longer lock-up periods. Other hedge funds may have no lock-up period at all.
When the lock-up period ends, investors may redeem their shares according to a set schedule, often quarterly. They normally must give 30 to 90 days’ notice so the fund manager may liquidate underlying securities and pay the investors.
Importance of a Lock-Up Period for a Hedge Fund
During the lock-up period, a hedge fund manager may invest in securities according to the fund’s goals without concern for share redemptions. The manager has time for building strong positions in various assets and maximizing potential gains while keeping less cash on hand. In the absence of a lock-up period and scheduled redemption schedule, a hedge fund manager would need a great amount of cash or cash equivalents available at all times. Less money would be invested, and returns may be lower. Also, because each investor’s lock-up period varies by his personal investment date, massive liquidation cannot take place for any given fund at one time.
Lock-Up Period for an IPO
The lock-up period for newly issued public shares of a company helps stabilize the stock price after it enters the market. When the stock’s price and demand are up, the company brings in more money. If business insiders sold their shares to the public, it would appear the business is not worth investing in, and stock prices and demand would go down.
When a private company works on going public, key employees are paid little in exchange for stock in the company. Because receiving stock is the equivalent of receiving a paycheck, many of these employees want to cash in their shares as quickly as possible. The lock-up period prevents stock from being sold at falsely inflated prices that are likely to drop after the company’s IPO.
Example of a Lock-Up Period
In March 2015, Alibaba Group Holding Inc.’s six-month lock-up period ended. Company insiders owning 437 million shares, approximately 18% of the outstanding shares, were allowed to sell their stock. Many investors were more concerned with receiving profits than with their cost basis. As a result, the stock price decreased dramatically.