The IPO Markets Are Changing, and so Is the Lock-up Agreement

An initial public offering (IPO) is a crucial time in the life of a company and its stakeholders.  Initial investors, employees, and executives can profit from the public listing, and the company can raise additional capital.  But IPOs come with a number of limitations, some required and some just common.  Today, lock-up agreements, once a common feature of IPOs, face a changing and uncertain future.

What is a lock-up agreement?

A lock-up agreement is a set period of time during which company insiders are restricted from selling shares, subject to limited and highly negotiated exceptions.  As the SEC notes, this lock-up period usually lasts for 180 days, and while federal laws require companies to disclose these agreements, lock-ups are not mandated except in certain states with “blue sky laws.”

Lock-up agreements exist to help minimize fluctuations in a company’s share price when the stock first hits the public market.  By preventing insiders from dumping shares quickly, a lock-up agreement restricts the supply of stock for sale on the public market, which, in turn, reduces the risks of potentially causing the stock price to plummet at an especially critical time.  In addition, a company typically agrees not to issue additional securities. The lock-up agreement is usually heavily negotiated with the underwriter. As Crunchbase notes, once a lock-up period ends, the free-market sale of stock shares by insiders can serve as a barometer of sorts.  If insiders hold their shares, perhaps they believe the price will rise, but selling shares may suggest otherwise.

With all the changes in market dynamics, investor priorities, and consumer interests due to the pandemic, the outlook for 2021 may be difficult to discern, but we can follow some trends.  From our experience, the 180-day lock-up period is still, by far, the most common length.  But despite that consistency, in recent times, there is a trend for companies to structure lock-ups with different lock-up periods for different parties.

Lock-up agreements in de-SPAC transactions

SPACs, or special-purpose acquisition companies, are also gaining traction as an alternative to IPOs to get private companies to market faster and at a lower price point. In a SPAC transaction, a newly formed company raises funds in the public markets via IPO, and then uses the proceeds to acquire a private operating company. Lock-up periods for SPAC transactions are typically longer than traditional IPOs (e.g., one year or more).

No lock-up agreements in direct listings

On the other hand, some companies are opting to achieve public listing by way of direct listings, as opposed to IPOs. In direct listings, existing shares are made available for trading in a public market without an underwritten offering, and, thus, without restrictions imposed by standard lock-up agreements, giving its existing shareholders immediate liquidity. Although underwriters are not engaged and these companies can save on costs, the companies’ ability to raise new capital is more restricted compared to IPOs. Spotify, Slack, Asana, and other well branded e-commerce businesses have successfully gone public via direct listing. Companies with track records of strong growth and healthy financials are good candidates for direct listings and can go public with no lock-up agreements. 

What to expect

To a certain extent, the deviations from the standard 180-day period of the lock-up arrangements should not be surprising.  We have seen similar trends of increasing democratization and disintermediation, particularly in the technology industry.  Time will tell whether lock-up agreements will be less important in listing processes going forward, or even end entirely.  

Louis Lehot is an emerging growth company, venture capital, and M&A lawyer at Foley & Lardner in Silicon Valley.  Louis spends his time providing entrepreneurs, innovative companies, and investors with practical and commercial legal strategies and solutions at all stages of growth, from the garage to global.

Eric Chow is an M&A lawyer with Foley & Lardner LLP in Silicon Valley.  Eric spends his time helping buyers and sellers navigate liquidity transactions with optimal outcomes.