What is a Lock-Up Option
A lock-up option is a stock option offered by a target company to a white knight for additional equity or the purchase of a portion of the company. Its purpose is ward off a hostile takeover attempt and the holder of the option is not free to sell the stock to any party other than a party designated by the target company.
Shares of the target company's stock are effectively locked up.
Also called a lock-up defense or lock-up provision. In risk-arbitrage, it may be called "shark repellent."
BREAKING DOWN Lock-Up Option
A lock-up option granted to a friendly suitor or savior helps to thwart the attempts made by a hostile acquirer. Whether it is a large percentage of stock or some of the company's major, and the most desirable, assets, the target company becomes less attractive for hostile takeover. These assets become available to the friendly suitor - the white knight - if that company does not win the merger. In other words, the favorable conditions of the stock or asset sale only happens if the white knight does not win the bid. However, it does compensate the white knights to make those bids with option serving as a breakup or termination fee.
This is also not in the same category as derivative financial options and therefore not subject to the same rules and regulations.
A lock-up option or defense should not be confused with a lock-up provision, which prevents a firm's shareholders from selling or transferring their shares during a defined period after acquiring them. This is typically implemented with employee stock grants after an initial public offering or other incentive awards.
Legal and Ethical Considerations
Lock-ups are somewhat similar to poison pill provisions in that they attempt to make the target company less attractive to suitors. A poison pill is a tactic utilized by companies to prevent or discourage hostile takeovers. A company targeted for a takeover uses a poison pill strategy to make shares of the company's stock unfavorable to the acquiring firm.
Also, the term poison pill is the common colloquial expression referring to a specially designed shareholder rights plan. A lock-up option is granted to the white knight company, not the target company's shareholders.