A friend asked me the other day: “What is a lockup period?” He told me that he heard of the term lockup period while reading an article about the LinkedIn IPO.

I thought I write an article to explain, in details, what is a lockup period.

Definition of the lockup period

A lockup period is a specific period of time immediately after the IPO (Initial Public Offering) during which insiders and associates of the company are prohibited to sell their shares in the company. These people are only allowed to sell their shares when the lockup period ends.

How long is the lockup period?

The lockup period varies from one company to the other, but typically it’s 6 months (180 days). So, if the IPO is set to be on January 1^st, 2012 then insiders and company’s associates cannot sell their shares until June 29^th, 2012 (180 days are a little less than 6 months). The lockup period can be as low as 3 months (90 days) and as long as a few years. The longer the lockup period, the more trustworthy (in my opinion) the company is.

Why is there a lockup period?

Imagine you are one of the co-founders of LinkedIn and you own something like 20% of LinkedIn. The day that LinkedIn was listed, you expected the stock to be trading at $5 (which is still 10 times the stock’s worth) but rather it touched $120. What you do is you get out of the game and you sell all your shares immediately, substantially lowering the price of the share after your sale, and making other investors lose a lot of money.

Now imagine that you are one of the co-founders of Dang, a company that is an Amazon clone in China. You knew Dang wasn’t worth $30 on the first day of trading, and you could have sold your shares then, but you had to wait for 6 months to do that. Note that Dang is now trading at $4.62, which his very close to the price I thought that the stock was worth when I wrote about it before.

In short, a lockup period exists to prevent owners and other insiders/associates from scamming investors by selling their shares (which they gave to themselves prior to the IPO) on the first few days of trading (it is a know fact that most stocks pop in the first few days of trading).

Who enforces the lockup period?

The lockup period is enforced by the market regulator (the SEC in the case of the American markets). Note that trades done by insiders are public and are published on the stock’s fact sheet (that exists on Yahoo finance, for example).

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