170 5 Equity and Shareholders’ Capital
limited-liability company can be freely transferable, there can be shares the
transferabilify of which is subject to restrictions (Volume I). (a) Generally, the
management of the transferability of shares can influence the terms on which a
limited-liability company can raise equity. The firm can benefit from the free
transferability of its shares. Free transferability can increase the number of
shareholders and mean that there is a market for shares. Free transferability and
better liquidity can reduce investors’ perceived risk, increase share price, and
reduce the firm’s costs for equity. Securities cannot be admitted to trading on a
regulated market unless they are freely transferable. (b) On the other hand, if
shares are freely transferable, anyone can buy them. The firm may restrict the
transferability of shares as a takeover defence (section 18.3 and Volume I). The
transferability of shares is often subject to restrictions in those limited-liability
companies that resemble partnerships. For example, the statutes of some
companies may provide that shares cannot be transferred without the consent of
the board. (c) Furthermore, large-scale sales of shares can depress share price. The
fear of large-scale sales can have the same effect. For this reason, the firm might
limit the sale of shares. For example, lock-up clauses are usual in IPOs (section
5.10.2).
According to a lock-up clause, important investors (such as banks, institutional investors
and large shareholders) have agreed not to sell their shares during a lock-up period. The
lock-up clause is a way to signal to smaller investors that there will not be any massive
sales of shares just after those investors have subscribed for their shares. As this will reduce
perceived risk, smaller investors are assumed to accept a higher price when subscribing for
the shares.
Withdrawal of funds. Whether and how a shareholder can withdraw funds from
the firm depends largely on its business form (Chapters 9 and 10). In a partnership
and limited partnership, the withdrawal of funds is a contractual matter. In a
limited-liability company, however, it is constrained by legal rules that restrict
distributions to shareholders.
In both cases, it may be in the interests of the firm to limit the withdrawal of
funds. An unlimited right to withdraw funds from the firm would increase
refinancing risk and the risk of insolvency.
For example, a hedge fund or a private equity fund could ask investors to agree to a lock-up
according to which they must keep their money in the fund for a minimum period before
redeeming it. In a hard lock-up, investors have no right to redeem before their time is up; in
a soft lock-up, they can get out early but have to pay a redemption fee of, for example, 3%-
5%. Most funds manage to bargain for one to two years. A five-year lock-up would be
unusual in the fund industry.^156 Lock-up clauses will be discussed in the context of exit.
(^156) All locked-up, The Economist, August 2007.