Lock-up period

Lock-up periods are essential tools that help hedge fund managers balance their need for stable capital with their investors' desire for liquidity. During a lock-up period, investors cannot withdraw their money from the fund. This gives managers predictable access to capital, which is crucial for executing their investment strategies effectively.

Investment managers typically require lock-up commitments that range from several months to multiple years. The length depends on the fund's investment approach and how easily the underlying assets can be sold. For example, a fund investing in highly liquid stocks might have shorter lock-ups than one investing in real estate or private companies.

The way lock-up periods work varies significantly between different fund structures. Some funds only restrict an investor's initial investment, while others apply lock-up requirements to every new contribution an investor makes. When only the initial investment is locked up, any additional money the investor contributes later is typically grouped together with the original investment for timing purposes. In contrast, funds that lock up each investment separately usually process redemptions on a "first-in, first-out" basis to determine which contributions have completed their required lock-up periods.

Lock-up arrangements come in several different forms, each designed to serve specific strategic and operational needs:

Hard lock-up completely prevent any redemptions during the restriction period. This gives managers maximum certainty about their available capital but offers investors no flexibility, even in emergency situations. While these arrangements provide the strongest protection for fund managers, they may make it harder to attract new investors due to their restrictive nature.

Soft lock-up allow early redemptions but charge penalty fees, typically between one and five percent of the amount being withdrawn. These fees are usually paid directly to the fund, benefiting the investors who remain. This structure gives managers some protection against sudden capital withdrawals while still providing investors with emergency access to their money, though at a cost.

Rolling lock-up periods create successive restriction periods after the initial lock-up expires. These are especially common in funds that invest in assets that are difficult to sell quickly, where the time needed to liquidate investments may extend beyond typical lock-up durations. For instance, a fund might have a two-year initial lock-up followed by annual opportunities to redeem, with each redemption triggering another one-year restriction period.

Redemption fee structures within soft lock-up arrangements often use tiered approaches to balance the interests of both investors and managers. Fees may decrease as the original lock-up period gets closer to expiring. For example, a fund might charge five percent for redemptions in the second year and three percent in the third year of a three-year lock-up period. Some funds charge higher fees during initial lock-up periods compared to later rolling lock-up phases.

Certain funds take a middle-ground approach by completely prohibiting redemptions during the early part of the lock-up period, then allowing fee-based redemptions in later phases. This gives managers absolute certainty about their capital during critical early investment periods while eventually offering liquidity options for investors who face compelling circumstances.

Lock-up periods serve important purposes even for funds that primarily invest in easily tradable securities like stocks and bonds. These restrictions help managers maintain viable fund sizes after launching and provide confidence in capital stability that is essential for executing long-term investment strategies. However, managers must carefully balance their need for capital protection against their continued ability to attract new investors and market their funds effectively.

The relationship between investment strategy and lock-up requirements has changed significantly over time. Some funds that invest in highly liquid assets historically imposed very long lock-up periods despite being able to easily sell their underlying investments. Recent market trends have moved toward more investor-friendly liquidity terms, particularly for strategies that can accommodate frequent withdrawals without hurting performance or treating remaining investors unfairly.

Investment managers often secure capital stability through specialized agreements with seed capital providers rather than incorporating lengthy lock-up periods into their standard fund terms. These side letter agreements frequently provide more flexible solutions to the capital stability challenge. However, seed investor typically demand additional benefits in exchange for their lock-up commitments, including potential ownership stakes in the investment management company and other preferential terms.

Once a lock-up period expires, investors become eligible to redeem their investments on the next available redemption date, subject to standard notice requirements. The calculation of when a lock-up expires depends on the fund's specific structure and when the investor initially subscribed. For example, an investor who makes an initial investment on July 1, 2023, in a fund with a two-year lock-up period and quarterly redemptions would first be eligible to redeem on September 30, 2025, and on each quarterly redemption date after that.

When investors have made multiple investments that are each subject to individual lock-up periods, redemption proceeds are typically paid on a first-in, first-out basis. This approach ensures proper tracking of which capital contributions have satisfied their respective lock-up obligations before becoming available for redemption.

The regulatory landscape surrounding lock-up periods remains stable as of 2025. The SEC's Private Fund Adviser RulesSEC regulations that would have imposed additional disclosure and operational requirements on private fund advisers before being overturned by the Fifth Circuit Court of Appeals., which would have imposed additional disclosure requirements around preferential liquidity terms, were overturned by the Fifth Circuit Court of AppealsFederal appellate court that reviews decisions from district courts in Texas, Louisiana, and Mississippi. in June 2024. This development preserved existing market practices for side letter arrangements and seed investor lock-up agreements. Fund managers continue to have flexibility in structuring lock-up terms and related liquidity provisions, subject to appropriate disclosure and fiduciary dutyLegal obligation to act in the best interests of another party, requiring utmost good faith and loyalty. to all investors.