What's Market: IPO Lock-Up Agreements and Lock-Up Covenants

Practical Law Canada Legal Update 0-627-8633 (Approx. 10 pages)

What's Market: IPO Lock-Up Agreements and Lock-Up Covenants

by Practical Law Canada Corporate & Securities
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This Practice Note provides an overview of lock-up agreements and covenants, including a discussion of key terms and the carve-outs typically negotiated for issuers and for directors, officers and shareholders. This Note also includes links to deal summaries for 2015 initial public offerings (IPOs) contained in the Practical Law Canada What's Market database, and summarizes the lock-up provisions and carve-outs found in such deals. This Note will be updated annually.
In a public offering of securities qualified by filing a prospectus under applicable securities laws in Canada, the underwriting agreement is the agreement between the entity issuing the offered securities (the issuer) and the underwriters. In a secondary offering (as opposed to a primary offering), the selling shareholder(s) is also a party to the underwriting agreement. For a general discussion of underwriting agreements, see Practice Note, Underwriting Agreement: Overview.
As part of the offering process for equity securities, the underwriters will generally request that the issuer refrain from selling equity securities of the issuer or engaging in similar transactions for a specified period of time after the offering. The underwriters or the issuer may also request that directors, officers and large or controlling shareholders submit to such restrictions (including any selling shareholders participating in the offering). These arrangements are referred to as lock-ups.
Lock-ups are intended to:
  • Provide a stable market for the securities and limit their trading volatility.
  • Prevent the market from being flooded with an oversupply of securities.
  • Help maintain market confidence in a company initiating an equity offering.
  • Ensure that insiders continue to keep a stake in the issuer.
Lock-up agreements typically include several exceptions or carve-outs from the terms of the lock-up to allow parties to engage in various transactions without seeking a lock-up waiver from the lead underwriters.
Although this Note is focused on lock-up provisions in the context of initial public offerings, they are equally applicable to follow-on offerings of equity securities.

What Is a Lock-Up Agreement?

For the issuer, lock-up arrangements are negotiated as a covenant in the underwriting agreement. In the case of directors, officers and shareholders, lock-up agreements are formalized in separate lock-up arrangements delivered before or at the closing of the offering. Receipt of these separate lock-up agreements by the underwriters is typically a closing condition in the underwriting agreement.
Whether as a covenant in the underwriting agreement or a standalone agreement, a lock-up provision will generally stipulate that the signatory will not sell securities similar to those being offered (including warrants and securities convertible into the securities being offered) for a specified period of time. Underwriters will generally seek lock-ups in offerings of equity securities and convertible securities where the securities are convertible into the issuer's common shares (or a similar actively traded class of equity securities).
For an example of a lock-up agreement applicable to directors, officers and shareholders, see Standard Document, Lock-Up Agreement: Securities Offerings.

Standard Length of Lock-Up: Issuer

The length of the lock-up period is negotiated with the underwriters. For issuers, this period is typically 180 days in an IPO.
Of the 19 IPOs on the Toronto Stock Exchange (TSX) in 2015, 14 were "traditional" IPOs in which the issuer was subjected to a 180 day lock-up. The remaining five deals were special purpose acquisition corporation (SPAC) IPOs, in which the issuer committed to a lock-up commencing on the closing date of the IPO and ending 30 days following the closing of the issuer's qualifying acquisition (except in the case of Dundee Acquisition Ltd., which agreed to both the 30 day restriction and a traditional 180 day lock-up).
For more on SPACs, see Practice Note, Special Purpose Acquisition Corporations (SPACs) in Canada: Overview.
It should be noted that, in 13 of the 14 "traditional" IPOs, the 180 day lock-up ran from the closing date of the offering. In the case of Shopify Inc., however, the lock-up ran from the date of the final prospectus. Shopify completed a $160 million cross-border IPO in May 2015.

Standard Length of Lock-Up: Directors, Officers and Shareholders

Though directors, officers and shareholders typically have the same lock-up period as the issuer, this is not always the case. There can also be instances where a specific shareholder has a different lock-up period than the other parties.
As noted in Table 1 below, 8 of the 14 "traditional" IPOs in 2015 included 180 day lock-ups for directors, officers and specified shareholders. The Stingray Digital Group Inc. IPO included a 24 month lock-up with staggered releases (15% after 180 days; a further 50% after one year; the balance after 24 months). As with the issuer lock-up, the lock-up applicable to directors, officers and shareholders of Shopify ran from the date of the final prospectus, rather than the date of closing.
Table 1
The SPAC IPOs included a lock-up for sponsors commencing on the closing date of the IPO and ending 30 days following the closing of the issuer's qualifying acquisition. In addition, the founders of each SPAC are subject to forfeiture and transfer restrictions under a separate agreement and undertaking.

Standard Prohibitions

A lock-up is rarely a blanket prohibition against any transactions in the stock. Usually, the parties negotiate exceptions or carve-outs to the lock-up agreement to permit certain types of transactions during the lock-up period. Negotiation of these exceptions can be the most variable and time-consuming aspect of negotiating lock-up agreements.
Lock-up restrictions and any material exceptions are described in the prospectus, with the level of detail varying depending on materiality and the presence of any unusual provisions.

Lock-Up Exceptions for Issuers

The primary concern of the underwriters is to maintain a stable market for the securities, rather than imposing unnecessary or prohibitive restrictions on the issuer. As a result, an issuer can usually negotiate lock-up exceptions that permit:

Sale of Securities to the Underwriters

The issuer must be able to sell shares to the underwriters to complete its obligations in the offering (including under any over-allotment option).

Equity Compensation

Grants of restricted stock, stock options or similar types of securities are a common component of employee compensation, serving as important recruitment and retention tools (see Practice Note, Equity Compensation in Canada: Overview). Issuers must retain the ability to issue shares or grant options, or both, under these plans. As a result, lock-up agreements frequently permit:
  • Grants of options, stock or similar awards under employee benefit plans.
  • Issuing stock on the exercise of outstanding employee stock options or other awards.
All of the 2015 IPOs, except the five SPAC transactions, included an exception for equity compensation.
The underwriters will typically conduct due diligence to get an understanding of the upper limits of the amount of stock that can be issued or granted under the lock-up exceptions for equity compensation. In addition, these exceptions are often limited to grants, awards, plans and options that: (a) exist as of the date of the underwriting agreement; or (b) are in the ordinary course of business.

Issuances in Connection with Acquisitions or Joint Ventures

Issuers that engage in or intend to pursue mergers and acquisitions, joint ventures or other types of business combinations as part of a strategic plan or other growth strategy will typically negotiate the ability to issue shares or other securities in connection with these transactions during the lock-up period.
An issuer's ability to issue equity as consideration for an acquisition or other business combination during the lock-up period provides an important financing alternative or supplement to debt financing. This exception is more common for issuers that have a track record for acquisitions as part of their growth strategy.
Of the 19 IPOs in 2015, seven included express exceptions for issuances in connection with acquisitions or joint ventures.
Acquisition and joint venture-related exceptions are sometimes subject to a limit on the number of shares that could be issued under the exception. The limit may be expressed in terms of a percentage, a fixed number or a dollar amount of shares. In the Shopify IPO, for example, the limit is expressed as a percentage (10% of the total number of shares issued and outstanding immediately following the completion of the transactions contemplated by the underwriting agreement).

Issuances in Connection with Pre-Existing Contracts

An issuer may have one or more pre-existing agreements (either with a third party or as part of an internal reorganization) that contemplate the issue or conversion of securities. The underwriters do not want the issuer to breach any of its existing agreements because that could lead to litigation and other adverse consequences for the issuer, which in turn could have a negative impact on the price and market for the securities.

Lock-Up Exceptions for Directors, Officers and Shareholders

As noted above, the primary concern of the underwriters is to maintain a stable market for the securities. As a result, underwriters want to avoid the negative perception that may occur when insiders sell shares in a company. In order to accomplish this, underwriters will often negotiate a different set of lock-up exceptions than those applicable to issuers and they may be more cautious about the types of transactions that they will carve out for the individuals' lock-ups.
Exceptions for directors, officers and shareholders may include the following:

Sale of Securities to the Underwriters

Any shareholders that are participating as selling shareholders in the offering must be able to sell shares to the underwriters to complete their obligations (including under any over-allotment option).

Financial and Estate Planning

This type of exception allows shareholders to include the locked-up securities in their financial or estate planning.
These types of transfers include:
  • Transfers as bona fide gifts.
  • Transfers by will or intestacy, usually limited to family members, immediate family members or trusts, partnerships or similar entities for the benefit of the locked-up party or its family members.
  • Transfers or distributions by a locked-up party of shares or securities convertible into common shares of the issuer to the locked-up party's subsidiaries, shareholders, partners or direct or indirect affiliates.
Transfers for financial or estate planning purposes are typically subject to a condition that the recipients of the securities agree to be bound by the terms of the lock-up.

Securities Acquired in the Open Market After Completion of the Offering

This exception permits locked-up parties to transfer securities that are purchased in the open market after the offering is completed.
To limit the negative perception of insiders selling stock, this exception is typically subject to the condition that no filing under Canadian securities laws or press release is required to be made by the issuer or the locked-up parties.
Of the 19 IPOs in 2015, just three included an exception for open market purchases after completion of the offering. This is perhaps an indication of underwriter concerns regarding the perception of stock sales by insiders.

Staggered Release

In some cases, underwriters and issuers informally agree that if the share price is performing well in the months after the IPO, the underwriters will waive the lock-up for a specified percentage of shares. However, in some cases underwriters agree to formally include this exception in the actual lock-up agreement. For an example of staggered release language to be included in a lock-up agreement, see Standard Document, Lock-Up Agreement: Securities Offerings.

Take-Over Bid

Generally, a lock-up provision will not exclude any transfer of the subject securities pursuant to a take-over bid, merger, plan of arrangement or similar business combination available to all holders of the securities, provided that if such transaction is not completed, the subject securities shall remain subject to the lock-up.

Stop Transfer Provision

Some lock-up agreements contain a stop transfer provision. Under this provision, the locked-up party consents to procedures that permit the registrar and transfer agent to refuse to register any transfer of subject securities by locked-up parties unless made according to the restrictions in the lock-up agreement. It serves as an additional precaution against violations of the lock-up agreement.
When a stop transfer provision is included in a lock-up agreement, stop transfer instructions are typically forwarded to the transfer agent as part of the closing documents for the offering.

2015 Initial Public Offerings

The following is a sampling of selected 2015 IPOs contained in the Practical Law Canada What's Market IPO database and summaries of their respective lock-up exceptions as disclosed in the underwriting agreement and prospectus filed on SEDAR.
The following summaries are included to provide a quick reference and a general indication of the type of exceptions included in these transactions. The summaries are not intended to be complete descriptions.
The full text of the lock-up covenants and exceptions applicable to issuers are included in the underwriting agreements for each transaction. The full text of the lock-up agreements applicable to directors, officers and other shareholders are typically included as exhibits to the filed underwriting agreements.

CPI Card Group Inc.

What's Market summary.
Lead Underwriters:
BMO Nesbitt Burns Inc.; Goldman Sachs Canada Inc.; and CIBC World Markets Inc.
Prospectus Date:
08 October 2015
Locked-up Parties:
Issuer, directors, executive officers, and all shareholders.
Lock-up Period:
180 days.
Exceptions to the lock-up for the issuer:
  • Pursuant to stock incentive plans referred to in the prospectus.
Exceptions to the lock-up for the other parties (partial list):
  • Bona fide gifts, provided the recipients agree to the lock-up.
  • Transfers by will or the laws of intestacy.
  • Transfers to limited partners or shareholders of the locked-up party, provided the recipients agree to the lock-up.
  • Shares to be sold under the underwriting agreement.
  • Open market transactions after closing.

Cara Operations Ltd.

What's Market summary.
Lead Underwriters:
Scotia Capital Inc.; BMO Nesbitt Burns Inc.; and RBC Dominion Securities Inc.
Prospectus Date:
31 March 2015
Locked-up Parties:
Issuer, directors, executive officers, and principal shareholders.
Lock-up Period:
180 days.
Exceptions to the lock-up for the issuer:
  • Shares to be sold under the underwriting agreement, including any over-allotment option.
  • Pursuant to stock incentive plans outstanding at the date of the underwriting agreement.
  • Issuances in connection with acquisitions or joint ventures.
    • Issuances in connection with pre-existing contracts.
Exceptions to the lock-up for the other parties:
  • Bona fide gifts, provided the recipients agree to the lock-up.
  • Dispositions to any trust for the benefit of the party of immediate family, provided the trust agrees to the lock-up.
  • Pursuant to a bona fide third party take-over bid or similar acquisition transaction

Spin Master Corp.

What's Market summary.
Lead Underwriters:
RBC Dominion Securities Inc. and TD Securities Inc.
Prospectus Date:
30 July 2015
Locked-up Parties:
Issuer, directors, executive officers, and principal shareholders.
Lock-up Period:
30 days after closing of the issuer's qualifying transaction.
Exceptions to the lock-up for the issuer:
  • Shares to be sold pursuant to the over-allotment option.
  • Employee stock options, grants under other security based compensation arrangements in the ordinary course and securities issued upon their exercise or settlement.
Exceptions to the lock-up for the other parties:
  • Bona fide gifts, provided the recipients agree to the lock-up.
  • Dispositions to any trust for the benefit of the party of immediate family, provided the trust agrees to the lock-up.
  • In the case of the Founders, transfers to Permitted Holders (as defined in shareholders agreement).
  • Pursuant to a bona fide third party take-over bid or similar acquisition transaction
End of Document
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Resource ID 0-627-8633
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Published on 11-May-2016
Resource Type Legal update: archive
Jurisdiction
  • Canada (Common Law)
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