The terms that a company and its directors, officers, and significant shareholders are subject to under a lock-up agreement can be the topic of much debate.
As an in-house counsel of a private company interested in going public, it is important to understand how lock-up agreements work. Lock-up agreements are generally required by underwriters in an initial public offering (“IPO”). Lock-up agreements are also commonly required when already publicly-listed companies want to do follow-on offerings of equity or equity-linked securities.
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Purpose of Lock-Up Agreements
One of the main purposes of lock-up agreements is to promote stability in the trading price of a company’s shares. Lock-up agreements effectuate this purpose by restricting sales of the company’s securities by the issuer, its directors and officers, and certain significant shareholders for a specified time period after the securities offering. The standard time period for which the parties are locked-up is 180 days after pricing.
Volatility or sharp depression of a company’s share price can cause investors to lose confidence. Lock-up agreements therefore help maintain market confidence about investing in a company’s securities.
Mechanics of Lock-Up Agreements
The lock-up agreements entered into with directors, officers, and important shareholders are typically separate agreements. A “Form of Lock-Up Agreement” is often attached as an exhibit to the underwriting agreement. The lock-up agreements with directors, officers, and important shareholders are signed relatively early in the deal process.
The lock-up agreement for the issuer is typically included as a covenant within the underwriting agreement itself. The underwriting agreement is executed shortly after the pricing stage of the offering.
The underwriters that are party to the lock-up agreement are particularly sensitive to who gets waiver rights. This refers to the rights granted only to certain underwriters to consent the release from lock-up restrictions. The lead underwriter will want to exclusively hold such consent rights. However, the other underwriters will push to also be granted waiver rights. The lawyers will have to carefully navigate these discussions between underwriters to prevent upsetting any of them.
Lock-up agreements should be discussed with the company and its counsel relatively early in the offering process. This can facilitate negotiation progress and allow time for challenging issues to be dealt with early on. Additionally, important shareholders do not have much incentive to sign a lock-up agreement that will restrict their ability to sell shares for a period of time. It can therefore be helpful to give them sufficient lead time to review the lock-up agreement and bring up any issues to the company.
Exceptions and Carve-Outs
The goal of maintaining price stability in the company’s stock price has to be balanced against giving certain important parties a degree of flexibility. As a result, lock-up exceptions are often negotiated for directors, officers, and certain shareholders. Common lock-up exceptions or carve-outs include:
- Sales of shares to underwriters
- Equity compensation
- Financial and estate planning
- The purchase of securities on the open market after completion of the offering
- Transfers to affiliates
- Transfers to the company
- Transfers to Rule 10b5-1 trading plans
- Early lock-up releases
One commonly negotiated carve-out to lock-up restrictions involves equity compensation. It is common for lock-up agreements to permit grants of restricted shares, options, and equity awards under employee benefit plans.
Financial and estate planning exceptions to lock-up agreements enable directors, officers, and certain shareholders to transfer locked-up securities by will or intestacy, as bona fide gifts, or to a qualified domestic order or divorce settlement pursuant to a court order.
Sometimes locked-up parties are allowed to acquire shares of the company on the open market after the offering closes. In order to minimize negative public attention, this carve-out typically includes language specifying that no changes in beneficial ownership need to be reported to the SEC on a Form 3, Form 4, or Form 5.
A carve-out allowing for transfers to affiliates can be used by locked-up parties that are corporations, limited liability companies, partnerships, trusts, or other entities in order to transfer securities to affiliated entities.
Early lock-up releases grant certain parties the ability to be released from lock-up restrictions ahead of the typical 180-day period if certain conditions are satisfied. Early lock-up releases can take the form of staggered releases or the shares can simply be released all at once. A key advantage of staggered releases is that they prevent a huge dip in the company’s stock price from occurring. Only a portion of the insiders holding locked-up shares are able to sell their shares when a staggered release is in place.