Legal Definitions - lockup option

A lockup option is a strategic defense mechanism used by a company to prevent an unwanted takeover by another entity. It grants a pre-arranged, "friendly" party the contractual right to purchase specific assets, divisions, or a significant block of shares from the target company at a predetermined price.

This right is activated only if a hostile bidder acquires a certain percentage of the target company's shares. The goal of a lockup option is to make the target company less attractive or more expensive for the hostile bidder, thereby discouraging the takeover attempt. However, such agreements must be carefully structured to ensure they genuinely serve the best interests of the company's shareholders, as courts may invalidate them if they are deemed to primarily protect management rather than shareholder value.

Here are a few examples to illustrate how a lockup option might work:

• Scenario: Protecting a Key Technology Division

  Imagine "TechInnovate Inc." is a software company with a highly valuable artificial intelligence division. They fear a larger competitor, "GlobalCorp," might attempt a hostile takeover to acquire this specific technology. To defend against this, TechInnovate enters into a lockup option agreement with "Alliance Ventures," a friendly investment firm. The agreement states that if GlobalCorp acquires 20% or more of TechInnovate's shares, Alliance Ventures will have the immediate right to purchase the AI division for a set price. This makes TechInnovate less appealing to GlobalCorp, as its primary target (the AI division) could be immediately sold off, diminishing the value of the takeover.

• Scenario: Diluting a Hostile Bidder's Stake

  "BioPharma Solutions" is a publicly traded company developing a promising new drug. A rival, "MegaDrugs Corp.," begins aggressively buying BioPharma's shares with the intent of taking over the company. To counter this, BioPharma has a lockup option agreement with "Evergreen Capital," a supportive institutional investor. This agreement allows Evergreen Capital to purchase a large block of newly issued BioPharma shares at a fixed, favorable price if MegaDrugs acquires 25% of BioPharma's outstanding shares. By exercising this option, Evergreen Capital would significantly increase the total number of BioPharma shares, thereby diluting MegaDrugs' ownership percentage and making its takeover attempt more expensive and difficult to complete.

• Scenario: Selling Off a Valuable Subsidiary

  "Retail Holdings Group" owns several distinct retail chains, including a highly profitable luxury goods subsidiary called "Elite Boutiques." When "Aggressive Acquisitions LLC" starts buying up Retail Holdings Group's stock, signaling a potential hostile takeover, Retail Holdings Group activates a lockup option. They have an agreement with "Partnership Investments," a friendly private equity firm, allowing Partnership Investments to buy Elite Boutiques for a predetermined sum if Aggressive Acquisitions LLC reaches a 30% ownership stake. The sale of Elite Boutiques would remove a major asset that likely attracted Aggressive Acquisitions LLC in the first place, making the remaining Retail Holdings Group less attractive and potentially causing the hostile bidder to abandon its efforts.