What is Lock Up?
Lock up in shares means locking up shares belonging to certain investors so that they cannot sell their shares for a while. This policy is enforced by the company that issues the shares. And it is generally done after the company conducts an IPO and starts selling its shares in the capital market.
Investors whose shares are restricted are from internal companies, such as: owners, commissioners, directors and ordinary employees. Apart from that, big investors such as venture capitalists, angel investors and others are also included in it.
These limits are usually enforced for quite a long time. Starting from 90 days or 3 months, 180 days or 6 months and even up to one year depending on the policies of each company.
Lock up is not only done by public companies. Private companies may also do so if there is an interest that drives the company to implement the policy. Although basically the lock up policy does not have rules and conditions set out in a law. So running it is a choice of each company.
But most of the companies that apply lock ups are companies that have done an IPO. They imposed a lock up as soon as the IPO was completed and the company’s shares began to be traded on the stock exchange. The general objective is to maintain stock price stability so that it is not affected by fluctuations triggered by transactions by irresponsible parties.
Benefits of Implementing a Lock Up Policy
On the surface, implementing a lock up seems to have a purpose to protect public investors from falling stock prices immediately after the IPO. However, behind this policy, companies basically want to save their own credibility by keeping their share prices stable after the IPO is carried out. So that in the eyes of investors, these stocks are categorized as potential stocks that have bright prospects in the future.
Of course, in trading transactions carried out by public investors, the company will not obtain additional capital. However, if the stock price has a good performance, in the future, when the company wants to issue new shares, these shares will get more attention from investors and the company will easily get bigger capital.
In addition, when companies issue other securities, such as bonds. The company will also gain more trust from investors. Because the credibility of the company itself is at a high level from the investor’s point of view. And it all started when the company’s stock performed well.
What if the company doesn’t lock up?
Lock up does not include rules or obligations that must be carried out by the company. The company, of course, can not lock up and not limit any actions to investors, both investors who come from internal and external companies.
However, the risk is that the company’s share price could weaken shortly after being listed and traded on the stock exchange, as a result of a sell-off by certain investors who held a sizable proportion of shares when the IPO took place.
This type of investor is usually only after short-term profits, and often makes extreme decisions. Even if it means hurting other investors.
Of course risks like that don’t always happen, so there’s no need to worry too much. However, if you want to avoid this risk, applying a lock up is the only option. At least to make the share price strengthen a few levels before the sale of shares by these investors is carried out, so that the share price is not corrected too deeply because the liquidity has increased, even though it is not significant.
How the Lock Up Period Works
The lock up period for hedge founds corresponds to each fund’s underlying investment. For example, a long or short fund that invests mostly in liquid stocks might have a one month lock up period. However, because event-driven or hedge founds often invest in thinner-traded securities such as distress loans or other debt, they tend to have prolonged lock-up periods.
However, other hedge founds may not have any lock ups at all depending on the investment structure of the mutual fund. When the lock up period ends, investors can redeem their shares according to a set schedule, often quarterly. They usually have to provide 30 to 90 days notice so fund managers can liquidate the underlying securities that allow payments to investors.
During the lock-up period, the hedge found manager can invest in securities according to the fund’s objectives regardless of the redemption of shares. Managers have time to build strong positions across multiple assets and maximize profit potential while keeping less cash. If there are no lock ups and scheduled redemptions, the hedge manager will need large amounts of cash or cash equivalents available at all times.
Less money will be invested, and returns may be lower. In addition, because each investor’s lock up varies by personal investment date, large-scale liquidations cannot be carried out for any given fund at one time.
What happens to the company’s stock price after the lock-up period ends?
The largest shareholder in a business can only freely sell their shares after the closing of the IPO is over. New shares will flood the market if the shareholder decides to sell his shares. If the stock price has increased since the IPO, then early investors may wish to profit by selling some of their investment, or if the price has decreased, then they may reduce their exposure.
However, that doesn’t mean they will sell at all costs because they can hold on to the stock in the hope that the price will go higher, or because they believe the stock can recover the value it lost in the early days of the company going public. A lot of attention has been on how the stock price performs versus the IPO price, but keep in mind that early investors tend to pay less. This means many early investors are still able to book profits even if the stock price underperforms after the IPO.
The end of the lock up period sends a strong signal about the confidence of the largest shareholders in the company’s prospects. If institutional investors decide to dispose of shares after the lock up period expires, this indicates that they have little confidence that the company is worth owning. If a small number of shares are sold by these investors, it means that they want to hold on to the shares and are optimistic about the prospects for the shares.
Usually, if there is a sharp increase in the number of shares available in a company then this will drive the share price down. It’s not uncommon to see stock prices fall the first day locked shares become tradable. In fact, if other investors who are not affected by the lock up period, start selling in the days before the lock up ends, then this is a sign that they expect the stock price to fall.
However, there is also an argument that the end of the lock up period may provide some support after an outright selloff as that also means there is increased liquidity in the stock. This is what financial institutions and large investors prefer. Liquidity can be retained during lockout periods as it is not uncommon for a majority of shares to be subject to them, which can mean they do not initially meet the criteria required by the institution or pension fund.
