Lock-up Period

There is more than one lock-up type

Lock-up periods themselves are easily understood – some fixed minimum period of months, quarters, or years before an investor can make a withdrawal for a given capital contribution.  However, it’s less known that there are multiple types of lockups; most commonly, they are as follows:

1. Hard lock-up.  In a hard lock-up, the investor waives the right to withdraw capital under any discretionary circumstance whatsoever, barring atypical events such as fund dissolution.  Regardless of what is happening in the markets or the performance of the fund, the manager has the right to enforce the lock-up period firmly in a hard lock-up.
2. Soft lock-up.  In a soft lock-up, the investor can actually withdraw capital from the fund before the lock-up period elapses; however, in such a structure, there is an agreed upon penalty fee that the investor must pay in such event.  Typically, the penalty fee is assessed against the entire withdrawal amount exercised, and is commonly ranged between 2-5%.

Fund managers generally have the right to make exceptions

A common provision in fund documents is to allow fund managers to, at their sole and absolute discretion, make exceptions to the lock-up period and withdrawal rights, such as waiving fees in a soft lock-up or allowing investors out early in a hard lock-up.  Given this right, a manager has the ability to in good-faith allow investors out despite what is contractually agreed to in certain extenuating circumstances and as they see fit, such as if the investment objective of the fund is failing.  However, a manager is under no obligation to allow any exceptions to what is otherwise agreed to.

How should I set my lock-up period?

Setting up the perfect lock-up period is more art than science, balancing a few key factors against each other.

• From the investor’s perspective, a longer lock-up period may be less attractive than a shorter one, as their investment becomes fully illiquid and out of reach.
• From the fund manager’s perspective, a longer lock-up period ensures that the manager is able to execute on its strategy without worrying about providing liquidity to investors or being affected by short term market voltality or macro conditions.   Letting an investor out of a fund is not simply a loss of assets under management, but could have a material adverse impact on all remaining investors in the fund if the fund must exit positions or change its behavior in order to provide the necessary exit-liquidity. Indeed, many fund managers would argue that a longer lock-up period is better for the investor, who may be jumpy during periods of volatility or turmoil and wish to exit a strategy prematurely or lock-in a loss.
• Relating to the fund’s strategy and asset type, certain strategies and assets naturally correspond to shorter or longer lock-ups.  Venture capital funds, as an obvious example, are effectively indefinitely locked up until an underlying private investment realizes a liquidity event, which could take a decade or greater.  As further examples, a concentrated long-only equity strategy or value investing strategy likely requires a longer lock-up as compared to a short-term options strategy or speculative digital asset strategy.

Ultimately, the fund manager is most often trading investor convenience for strategy security.  If an investor is unwilling to commit, or would only commit a lesser amount to a fund with a longer lock-up period, but would commit more to the same fund if the lock-up was shorter, the fund manager must consider the pros and cons and make the decision as to whether making an exception to the lockup period is sensible or not.