Direct Listing Becomes More Attractive, but Not for All Companies Going Public
The US Securities and Exchange Commission recently approved a proposed change to NYSE listing rules that would allow private companies to raise capital through a direct listing.
Like an initial public offering, or IPO, a direct listing on a stock exchange is a means for shareholders of a private company to sell their equity to outside investors. However, unlike an IPO, there is no initial sale to underwriting banks or pre-opening sale of shares to initial buyers, typically institutional investors. Rather, the initial sale of the shares is conducted through a stock exchange, with the initial price determined by matching buy and sell orders, as occurs for the shares of any listed company each trading day.
Because the shares are not sold at a discount to underwriting banks and banker fees are substantially lower, a direct listing is a far less expensive way for a company to go public and for selling shareholders to maximize what they receive for their shares. Until the SEC’s approval of the NYSE’s rule change, companies that chose this alternative route to going public were unable to raise capital. What it did do was create liquidity for existing shareholders (investors and employees) at the IPO and eliminate the need for the typical 180-day lock up period post IPO. The most notable companies to choose this option prior to the new SEC ruling are Spotify Technology (2018), Slack Technologies (2019), Palantir Technologies (2020) and Asana (2020).
Now, in a single public transaction, shareholders of a private company can monetize their stake while capital to fund the company’s growth can be simultaneously raised from outside investors.
This added benefit has made the direct listing attractive to companies in need of cash or with a desire to enhance their capital structure. But like any transaction in the capital markets there are advantages and drawbacks, which vary by company. In light of the recent SEC ruling, it’s worth revisiting each, as “one size does not fit all” companies going public.
Advantages of direct listing
- No underwriting fees, which can range from 3% to 7% of shares sold, although other costs remain, such as auditing and legal fees
- Thus, more money is raised by the company if there is strong public demand for issued shares. Such demand is typically associated with companies that have strong brand awareness.
- Selling shareholders and company can benefit from any spike in the share price (this was not the case for Airbnb’s recent IPO, which took the traditional route to going public and saw its shares double by the end of the first trading day)
- No lock-up period for selling shareholders, which also allows the company going public to establish its market valuation sooner, as future dilution is eliminated under a direct listing
- A transparent process and natural price discovery, as the price of the shares being sold is purely market driven
- Ability to market to investors that the company believes would be most appropriate as shareholders and build a shareholder base accordingly
Disadvantages of direct listing
- Without underwriters, there is no fixed price for the shares in advance of the public listing (a pro or con)
- With conventional IPOs, the underwriting banks actively market the offered shares to their institutional clients, whereas a company pursuing a direct listing must identify appropriate investors and market the offering directly to them, a complex and time-consuming process; it should be noted that even when investment banks are hired as advisors for a direct listing, they are legally prohibited from marketing the company’s offering to investors
- For companies that are not well known and/or are complex in nature, public demand can be weak, potentially resulting in a less desirable price for the shares being sold and in high volatility or poor trading liquidity without a backstopping bank, which can be a major deterrent for institutional investors
- No immediate research coverage and less ongoing marketing by investment banks, such as participation in equity conferences and the organization of future non-deal roadshows to meet with institutional investors
- If paying investment banks to provide research coverage, time must also be devoted to educating banks analysts, apart from marketing to institutional investors
- Management and investor relations teams must work harder and start earlier to achieve sufficient visibility for the company in the global equity markets and demand for the shares prior to and after the offering
To learn how InspIR Group can advise and support IPOs as well as a direct listing in the US, please contact:
+1 (212) 661-2243
+55 (11) 98103-0201