What is a Lock-Up Period?
A lock-up period may be a window of your time when investors aren’t allowed to redeem or sell shares of a specific investment. There are two main uses for lock-up periods, those for hedge funds and people for start-ups/IPO’s.
For hedge funds, the lock-up period is meant to offer the hedge fund manager time to exit investments which will be illiquid or otherwise unbalance their portfolio of investments too rapidly. Hedge fund lock-ups are typically 30-90 days, giving the hedge fund manager time to exit investments without driving prices against their overall portfolio.
For start-ups, or companies looking to travel public through an IPO, lock-periods help show that company leadership remains intact which the business model remains on solid footing. It also allows the IPO issuer to retain additional cash for continuing growth.
How a Lock-Up Period Works
The lock-up period for hedge funds corresponds with the underlying investments of every fund. for instance , a long/shortfund invested mostly in liquid stocks may have a one-month lock-up period. However, because event-driven or hedge funds often invest in additional thinly traded securities like distressed loans or other debt, they have a tendency to possess prolonged lock-up periods. Still, other hedge funds may haven’t any lockup period in the least counting on the structure of the fund’s investments.
When the lock-up period ends, investors may redeem their shares consistent with a group schedule, often quarterly. They normally must provides a 30- to 90-day notice in order that the fund manager may liquidate underlying securities which permit for payment to the investors.
Lock-up periods are when investors cannot sell particular shares or securities.
Lock-up periods are wont to preserve liquidity and maintain market stability.
Hedge fund managers use them to take care of portfolio stability and liquidity.
Start-ups/IPO’s use them to retain cash and show market resilience.
During the lock-up period, a hedge fund manager may invest in securities consistent with the fund’s goals without fear for share redemption. The manager has time for building strong positions in various assets and maximizing potential gains while keeping less cash available . within the absence of a lock-up period and scheduled redemption schedule, a hedge fund manager would wish an excellent amount of money or cash equivalents available in the least times. Less money would be invested, and returns could also be lower. Also, because each investor’s lock-up period varies by his personal investment date, massive liquidation cannot happen for any given fund at just one occasion .
Lock-up periods also can be wont to retain key employees, where stock awards aren’t redeemable for a particular period to stay an employee from moving to a competitor, maintain continuity, or until they need completed a key mission.
Example of a Lock-Up Period
As an example, a fictitious hedge fund, Epsilon & Co., invests in distressed South American debt. The interest returns are high, but the market liquidity is low. If one among Epsilon’s customers sought to sell an outsized portion of its portfolio in Epsilon at just one occasion , it might likely send prices far less than if Epsilon sold portions of its holdings over a extended period of your time . But since Epsilon features a 90-day lock-up period, it gives them time to sell more gradually, allowing the market to soak up the sales more evenly and keep prices more stable, leading to a far better outcome for the investor and Epsilon than may otherwise are the case.
The lock-up period for newly issued public shares of a corporation helps stabilize the stock price after it enters the market. When the stock’s price and demand are up, the corporate brings in additional money. If business insiders sold their shares to the general public , it might appear the business isn’t worth investing in, and stock prices and demand would go down.
When a personal company begins the method to travel public, key employees are paid little in exchange shares of company stock. Because receiving stock is that the equivalent of receiving a paycheck, many of those employees want to take advantage their shares as quickly as possible after the corporate becomes publicly traded. The lock-up period prevents stock from being sold immediately after the IPO when share prices could also be exaggerated and certain to drop after the company’s IPO.