A lock-up agreement is a legal agreement signed by all the shareholders of a company, which restricts them from selling any shares of the company’s stock for an agreed period of time. There are no federal laws governing lock-up agreements; these are instead usually determined by the underwriters and the issuer and its directors, officers and control persons in connection with offerings of securities. The decision to enter into lock-up agreements is usually made by the underwriter. These lock-up agreements are commonly used as part of the Initial Public Offering (IPO) process and to protect a new stock from heavy insider selling — flooding the nascent market for the company’s shares and driving the price down. Insiders, compared to the general public, own disproportionately high percentages of stock shares at the time of an IPO. As a result, their selling activities could significantly impact a company’s share price immediately after the company goes public. Sometimes, lock-up periods also serve an additional purpose: they burnish the appearance to the investing public that insiders have long-term faith in the listing company’s prospects.
The IPO process is where a previously unlisted company sells new or existing shares on a stock exchange and offers them to the public for the first time. Prior to an IPO, a company is private – with a relatively smaller number of shareholders, limited to accredited investors or qualified institutional buyers. After an IPO, the issuing company becomes a publicly listed company on a recognized stock exchange – often known as the company “going public.” Existing owners of the company’s shares can cash out if they choose to when the company goes public, following an IPO. However, those shares can only be sold following a lock-up period. For a traditional IPO, the lock-up period typically lasts for 180 days, with some variations for staggered or performance-based early releases.
For most IPOs, even the most high-profile IPO insiders agreed to the 180-day standard for lock-up periods. Despite this, there have been rumors in the press that in a few instances, some stockholders circumvented the lock-up restrictions by selling stock short or engaging in hedging (both of which are prohibited under the lock-up agreements). There have, however, been some variations to the 180-day lock-up period. Pertinent examples of non-standard lock-up agreements include Snap Inc. and Dropbox, Inc. Snap Inc.’s directors, officers and shareholders agreed that without the prior written consent of either of the representatives acting on the underwriters’ behalf, they would not engage in sales or transfers for a 150-day period. Snap, Inc. also staggered the expirations of the lock-up agreements on occur on different dates, allowing different groups of people to sell their shares to begin to sell their shares at different times. Dropbox, Inc. and its underwriters allows the company’s lock-up period to expire earlier than contemplated under the lockup agreement.
Special Purpose Acquisition Companies (SPACs) are public companies formed for the purpose of merging with private companies. The SPAC IPO process is analogous to the reverse of a traditional IPO. In a traditional IPO, an operating company goes public by selling new shares to public investors, which can then be freely traded. Conversely in a SPAC listing, the acquisition company goes public solely holding cash and the acquisition company then identifies and acquires a target company. These so-called “blank-check” shell companies have no operations or business plan other than to acquire a private company using the money raised through an IPO, thereby enabling the target company to quickly list its shares. This process involving the previously private company becoming a publicly traded company is sometimes referred to as a “de-SPAC transaction.” As an industry expert puts it(1), “You can think of it like: an IPO is basically a company looking for money, while a SPAC is money looking for a company.” (Don Butler, Managing Director at Thomvest Ventures)
The difference between the two is also reflected in their respective lock-up periods. After a SPAC merger, the target shareholder’s equity may be more restricted than in an IPO. For SPAC sponsors, the lock-up period for SPAC IPOs is typically longer than for traditional IPOs. SPAC Sponsors agree to these longer lock-up periods to provide time for the acquisition company to identify a target company. Most of the SPACs from 2019 and early 2020 provided that the SPAC sponsors are subject to a one year lock-up period. Conversely, the target company’s shareholders agree to standard 180-day lock-up periods (given that no further time must be allocated once the target company has been identified). As with traditional IPOs, there are variations to timing for these lock-ups. For example, if pricing triggers are met and the trading price of the company’s stock reaches certain thresholds then SPAC sponsors may become subject to shorter lock-up periods.
Recently, DraftKings merged with Diamond Eagle Acquisition Corp. (DEAC), a SPAC, and SBTech, a betting and gaming technology company. Ever since, DraftKings’ stock price has been soaring and industry analysts have attributed this to the thin number of floating shares — around 40 million floating shares out of over 437 million total class A shares. The founders and directors of the SPAC company, DEAC, before the reverse merger, initially had a one-year lock-up period from the date of completion of the reverse merger dated April 24, 2020. This lock-up period was then shortened to 180 days; the stock traded at over $15 for at least 20 out of 30 consecutive trading days, and as a result, the condition under the lock-up agreement was met and the lock-up period was shortened. Given that the SPAC sponsors and DraftKings officers and employees became subject to the same length lock-up period the float of the stock increased 10-fold after the expiration of the lockup agreement. As the insiders rushed to sell their shares after the expiration of the lock-up period, it would result in a dip in DraftKings’ stock. Before the expiration of the first lock-up agreement, the stock traded at over $63 per share at the end of September 2020. As successive lock-up periods expired in October, the stock fell to $35.40 per share before rebounding.
2020 was record-breaking year for SPACs, with SPACs conducting as many as 248 IPOs and raising over $83 million. By contrast, 2019 – also considered to be an unprecedented year for SPACs – witnessed only fifty-nine SPAC IPOs and $13.6 million raised. This boom in SPACs and the accompanying market changes might have some implications on lock-up agreements.
Fenwick and West LLP’s corporate group recently surveyed more than 80 US-based technology companies that have consummated an IPO since January 1, 2017 to determine whether these recent market changes have meaningfully altered lock-up agreement terms. They survey focused on three key lock-up agreement terms: length of lock-up, blackout release provisions and price-based release provisions. It was observed that the lock-up period for IPOs generally remained the same (180 days), with one company following a staggered lock-up release system, wherein 20% of the shares were released from lock-up after 120 days and the remaining shares followed after 180 days. Under a blackout release provision, if the lock-up expires during a blackout period (a period when directors, officers and employees are not allowed to trade under the company’s insider trading policy), insiders would not be able to sell until expiration of the blackout period, which effectively extends the lock-up period. In recent offerings, changes have been observed that provide that if the lock-up period expires during a blackout period, the lock-up is released a certain number of days in advance of the blackout period to allow insiders to sell. Finally, only four out of all the companies (5% of the sample) surveyed had a price-based release structure. The rise of SPACs that dramatically accelerated in 2020 has certainly changed the landscape for companies going public. Lock-up agreements are slowly changing in tandem with these trends, particularly for larger companies that can negotiate with underwriters to obtain shorter, bespoke and narrowly-tailored lock-up terms.
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