A lock-up is a promise you make about your own future, and you make it without knowing what your future will need. Here is what is on the other side of that promise.
10 min read · Level 4
Illiquidity is usually discussed as a risk, and that framing quietly misses what is being traded. A lock-up does not make an outcome more uncertain - the underlying asset behaves the same either way. What it removes is optionality: the right to change your mind, to respond to news, to meet an obligation you did not foresee. Options have value, this one is being sold, and the reason it is so often sold too cheaply is that the buyer names a price and the seller has no way to compute one. There is a harder version of this point that is worth sitting with. Some of the best long-horizon results in investing were produced by people who genuinely could not sell, because the constraint removed the behaviour that destroys returns - panic at the bottom. That is real, and it means a lock-up can be worth accepting for reasons that have nothing to do with what you are paid for it. But it is a poor argument for any particular lock-up, because it rests on your own expected misbehaviour, and an investor who needs a contract to prevent panic should notice that conclusion rather than build a portfolio on it.
Illiquidity arrives in several different shapes, and they are not equally severe. Worth being able to tell them apart.
A lock-up period is a contractual window during which you may not withdraw at all. Common in private funds and in shares issued before a listing. A redemption window is weaker: you may withdraw, but only at stated intervals, and usually with notice. Quarterly with 90 days' notice means the money can be up to six months away. A gate provision is the escape hatch the vehicle keeps for itself. If too many investors ask to leave at once, it may limit or suspend withdrawals - which means the restriction tightens precisely when other people have also decided they want out, and that is the moment you are most likely to want out too. A capital call is the mirror image. You commit an amount, the manager draws it down over years at times of their choosing, and until it is called you must keep it available. Committed capital is therefore illiquid in both directions: you cannot get it back and you cannot fully use it. A secondary market, where one exists, is the exit of last resort - selling your position to another investor rather than back to the vehicle. It is a market with few buyers, and prices reflect that.
No asset is illiquid in isolation. Illiquidity is a relationship between how long the asset takes to sell and how soon you might need the money.
Because the cost of a lock-up is not paid evenly. It is nothing at all, for years, and then it is everything, once - in the month a job ends, a business needs capital, or a health event arrives.
That shape is what makes it easy to underprice. On the day you sign, the restriction costs nothing and the compensation is visible, so the trade looks free. The bill comes due in a state of the world you were not imagining while signing, which is the definition of a risk that gets underweighted.
And because illiquidity interacts with everything else you own. A portfolio can be well diversified by asset and badly concentrated in liquidity - and in a genuine emergency, what you can sell, not what you own, is what you have.
This is educational information, not investment, securities or financial advice. Rules differ by country and change — get advice from a qualified professional in your jurisdiction before acting.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
Sources: U.S. SEC — Investor.gov; FINRA — investor information; UK FCA — information for consumers; IOSCO — global securities regulators
Commit 100,000 to a vehicle with a ten-year life and no redemption rights. Suppose it works: by year four the position is carried at 150,000.
Now suppose you need the money in year four, for reasons that have nothing to do with the investment.
There is no redemption. The only route is a secondary sale, and in a market with few buyers the bid arrives at a 25% discount to the carrying value:
carried at 150,000 bid at a 25% discount 112,500 given up 37,500
What that does to the result: 100,000 turned into 112,500 over four years is 2.99% a year. Holding to the end of the ten-year life at a 2.0x multiple - 100,000 becoming 200,000 - would have been 7.18% a year.
The investment did not change. Your circumstances did, and the terms converted a circumstance into a permanent loss of 37,500 against the carrying value. That is what the lock-up actually costs: not the inconvenience of waiting, but the discount you accept if you cannot.
And note the direction of the discount. It is not a judgement about the asset - the buyer may agree entirely with the 150,000 mark. It is a price for your urgency, and it is larger the more visible your urgency is.
The commitment side is worth pricing too. If 100,000 is committed and the manager draws it over five years, the uncalled portion cannot be invested in anything you might not be able to liquidate on demand. That capital is working at cash rates, in a vehicle you chose for its higher expected return. The next lesson computes what that does to the return on the whole commitment.
The specific wrong move is deciding how much to lock up by asking what you can spare, rather than by asking what a bad year looks like.
'I will not need this' is a forecast about the next decade of your own life made in a month when nothing is wrong. The relevant question is different and much harder: if income stopped for a year at the same time as markets fell, what would you be able to sell, and would this be in that list?
It is tempting because the compensation for locking up is quoted and the cost is not. One side of the trade has a number attached and the other has a feeling, and numbers win that argument every time.
The second mistake is reading a stated term as the real one. A ten-year fund life commonly carries extension options, and the wind-down of a final holding can add years beyond that. A quarterly redemption right sits beside a gate that can suspend it. The term in the marketing document is the best case, and the document that matters is the one with the extension and gate provisions in it.
Take the stated term, add every extension the documents permit, and add the time a final asset could take to sell. That later date is the one to plan around, because it is the one the documents allow.
They are in the offering document rather than the summary. The two questions: what triggers them, and who decides. A restriction that activates on the manager's discretion in a stressed market is a different instrument from one with a fixed numeric trigger.
Count every position with a restriction, including committed-but-uncalled capital, and express the total as a share of your investable assets. Liquidity is a portfolio-level property, and nobody notices the accumulation because each commitment was reasonable on its own.
The purpose of the liquid portion is not return; it is to make sure no outside event ever forces a sale at a discount. That reserve is what converts a lock-up from a risk into a choice.
Ask the manager directly whether transfers are permitted at all, whether consent is required, and whether any have happened. 'A secondary market exists' and 'positions in this vehicle have traded' are very different statements, and only the second one is an exit.
Before committing to anything with a redemption restriction, and periodically across the whole portfolio to see how much is restricted in aggregate.
Do not treat every restriction as equivalent. A 90-day notice period and a ten-year lock with extension rights differ by more than duration, and refusing all illiquidity forecloses asset classes that may genuinely suit a long horizon.
Open-ended vehicles holding assets that take months to sell - property being the recurring example - offer investors the right to withdraw far faster than the underlying holdings can be converted to cash. The arrangement functions while withdrawals are normal and fails when they are not, and the response, provided for in the documents, is to suspend redemptions until assets can be sold in an orderly way. Investors in such funds in various markets have found their money unavailable for extended periods, having bought something described as liquid.
Compare the redemption terms with how long the underlying assets actually take to sell. Where the terms are faster than the assets, the liquidity is a feature of calm conditions, and the suspension clause is the true term.
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