Lock-up provision refer to restricting the sale or transfer of shares post-transaction. For example, after an IPO, the original owners of the business often have their shares locked up to stop them from dumping them on the market shortly after the listing. In this case, it creates alignment with the new shareholders to facilitate a smooth transition. This also applies to private equity transactions.
However, in private equity transactions, the lock-up provision period is often for the duration of the investment. That means, the entrepreneurs cannot sell or transfer their shares until a planned exit event unless approved by the private equity investor. In instances where approval is granted, the shares typically have to be offered to the private equity investor first (this is referred to as Right of First Refusal). If the private equity investor refuses to participate, they may allow a sale to an approved investor.
This term may seem overly onerous, but considering the expected investment horizon, private equity firms want to keep share register disruption to a minimum. Allowing shares to be traded freely causes unnecessary overhead and has the potential of allowing devisive investors onto the register. That’s the Term Sheet Lock-up Provision.