How do lockups and Rule 144 affect sellers who take holdco stock?

What does a seller need to know before taking holdco stock?

This article is written from the seller's side. For how the company issues the shares and registers them, see how to register shares issued to sellers and when they can sell. Here the question is how long you will be stuck, what you can sell afterward, and what filings and price risks come with the stake.

Which clock controls when you can sell?

Three clocks can run at once, and the longest one wins.

1. Rule 144 holding period. Six months if the company has reported to the SEC for at least 90 days before the sale, one year if not. It runs from the date you acquired the shares from the company, and it does not begin until the full price or other consideration has been paid or given (17 CFR 230.144 (Cornell LII copy)). Signing alone does not start it.
2. The lock-up. A contract term with no standard length. Negotiate it.
3. Shell status. If the company was ever a shell, Rule 144(i) bars resale until it meets extra conditions, including current reporting and one year from the date it filed Form 10 information.

Registration for resale can shorten the first clock, not the lock-up.

What limits apply after the lock-up ends?

The limits depend on whether you are an affiliate, meaning you control or are controlled by the company or are under common control with it.

• Non-affiliate. No volume cap after the holding period, and after one year the current-information condition falls away (17 CFR 230.144 (Cornell LII copy)).
• Affiliate. In any three months you may sell no more than the greatest of 1 percent of the class outstanding or the average weekly volume over the prior four weeks. A seller who takes a board seat, an executive role or a large stake can be an affiliate. Ask your lawyer before closing.

What filings follow a large stake?

• Above 5 percent. A person who acquires more than 5 percent of a class registered under Section 12 of the Exchange Act generally files a Schedule 13D within five business days, unless a short-form Schedule 13G is available (17 CFR 240.13d-1 (Cornell LII copy)). A holder not seeking control and under 20 percent may qualify for Schedule 13G.
• Above 10 percent, or as an officer or director. For a class registered under Section 12, Section 16 requires ownership reports. Profit from a purchase and sale within any period of less than six months can be recovered by the company (15 U.S.C. 78p (Cornell LII copy)).

These rules turn on the facts, so get advice before signing.

What does the timeline and price risk look like in numbers?

Assumptions. You sell your business for 1,200,000 holdco shares at $2.50, a value of 1,200,000 x 2.50 = $3,000,000. The holdco has 20,000,000 shares outstanding, so you own 1,200,000 / 20,000,000 = 6.0 percent, above the 5 percent filing line if the class is registered under Section 12. Average weekly volume is 60,000 shares. The lock-up is 12 months. The company is a current reporting company.

• If you are an affiliate: 1 percent of 20,000,000 is 200,000, which is greater than 60,000. You may sell 200,000 per three months, so 1,200,000 / 200,000 = 6 periods, about 18 months after the lock-up ends.
• If you are not an affiliate: no volume cap, but the market sets the pace. If daily volume is 15,000 shares and you sell 20 percent of it, that is 3,000 a day, so 1,200,000 / 3,000 = 400 trading days, about 1.6 years.
• Price risk: if the price is $1.75 when you can first sell, the stake is worth 1,200,000 x 1.75 = $2,100,000, which is $900,000 or 30 percent less than at closing.

The share count is fixed in this example, so you carry the price risk.

What can you negotiate?

• A shorter lock-up, or a leak-out that lets you sell part each period.
• Registration rights, so you can sell without relying on Rule 144.
• A larger cash share, or a collar or top-up that protects part of the value. See how fixed shares and fixed value differ.
• Tax treatment. The regulation's examples treat 40 percent stock as preserving continuity for deferral and 25 percent as not (26 CFR 1.368-1 (Cornell LII copy)). Ask a tax advisor what is due at closing.

Where these numbers come from: Holding periods, the volume cap and shell limits are from 17 CFR 230.144 (Cornell LII copy). Schedule 13D and 13G timing is from 17 CFR 240.13d-1 (Cornell LII copy), and Section 16 from 15 U.S.C. 78p (Cornell LII copy). Tax examples are from 26 CFR 1.368-1 (Cornell LII copy). The share counts, price, volumes and lock-up in the example are assumptions. Confirm with a securities lawyer.

Related questions

Does the Rule 144 clock start at signing or at closing?

The rule runs the clock from the date you acquire the shares, and not before the full consideration is given, so signing alone does not start it. For shares received as the price of your business, ask your lawyer to confirm the start date in your deal.

Can I sell part of my shares during the lock-up?

Only if the agreement says so. A leak-out is the usual way to allow limited sales.

Who pays for registering my shares?

The contract decides. The company usually bears the cost, but you should confirm that and any deadline in the agreement.

What comes next

If the shares trade on an over-the-counter market, read whether you can use OTC stock as acquisition currency.

Related articles

• Can you use stock in a holdco that trades on OTC?
• How do you register shares issued to sellers, and when can they sell them (Rule 144, lockups)?
• How do sellers who take public stock get liquidity?
• Why do sellers accept public stock more readily than private stock?
• Can a seller defer taxes by taking stock?

Meraki Dealmakers is a service of Meraki Partners, LLC, an advisory firm. It is not a broker-dealer, investment adviser, business broker, law firm or accounting firm. This article is general information, not legal, tax or investment advice.