February 20, 2020
One of the rising trends for companies seeking to go public is direct listings, according to industry experts.
A direct listing, as opposed to an initial public offering (IPO), is a more streamlined, cheaper option to be listed on a stock exchange. The main drawback, however, is it’s not a way for a company to raise additional capital.
In the past, only smaller companies started trading using a direct listing. Most of these have been in the biotech or life sciences sectors.
More recently, two high-profile direct listings hit Wall Street:
And more appear to be on the way, according to prominent tech investor Bill Gurley, a general partner at the venture capital firm Benchmark Capital. Gurley hosted a well-attended conference in San Francisco last year for start-up entrepreneurs and venture capitalists that focused on direct listings. Notable possibilities include Airbnb and GitLab, according to news reports.
So it’s no surprise that we’ve been getting questions about direct listings from clients and friends who lead and hold shares at private high-tech firms. They rightly wonder how a direct listing could impact their financial goals. Here’s a brief comparison of the two public listing methods and the pros and cons of going direct.
In a traditional IPO, a company going public hires an investment bank to underwrite and generate interest in the company shares. The process usually includes a formal roadshow where the company and the investment bank travel from town to town meeting with potential investors — typically large institutions, other investment banks and limited qualified accredited investors. The goal is for the investment bank to tell the company’s story and get investors to submit large orders to purchase stock shares at the IPO price. A short time later, company shares are made available on stock exchanges, known as the secondary market, where the price can change dramatically from the initial IPO price.
A direct listing, also known as a direct public offering (DPO), is an easier way for early investors and employees of the company to monetize their investment. It involves the sale of shares directly to the public on stock exchanges with no lockup period. No underwriters are used to price the offering and pump up interest in the issue, so shares start selling at what investors are willing to pay. Importantly, no new shares are issued, and no new money is raised for the firm.
One primary reason companies are leaning toward a direct listing of shares is to avoid paying millions of dollars in fees to investment bankers. A traditional IPO can cost a company several percent of the dollar amount raised. A direct listing is not costless, but the investment banker fees are much less because their role is more limited to the filing process and compliance responsibilities.
Another benefit with a direct listing is the absence of the mandatory lockup period. Investors who commit to buying shares in the traditional IPO process almost always insist on being protected against insiders and other major shareholders selling their shares for a period of time — usually six months.
One of our clients is in the midst of a lockup period now, and her emotions are linked to the daily stock price movement. It can lead to emotional angst.
A lockup period, however, is not required with a direct listing, so existing shareholders have the freedom to sell their shares at any time. This makes it much easier for financial planning and reducing concentrated wealth.
The other major positive that direct listings have over IPOs is it doesn’t dilute the holdings of existing shareholders. Since no new shares are issued, the level of employee ownership in the firm is maintained.
Other benefits include:
Perhaps the biggest reason not to use a direct listing of shares is that it does not raise any new capital for the company. If a company needs additional capital to facilitate future growth, a traditional IPO may be a better choice.
A direct listing may also result in initial price volatility because there are no large shareholders — usually including the underwriter — to help support the stock price after the shares begin trading. Without a mandatory lockup period, shareholders may choose to sell their shares and cause the price to fall.
For some companies that are not well known, opting for a direct listing also makes it harder to tell their story to potential investors. The pre-IPO roadshow is often used to publicize the company and highlight its past and future accomplishments. Without it, the company will have to rely on other methods that fit within the Securities and Exchange Commission’s marketing rules.
For any company, the day its shares begin trading on a public exchange is a major milestone. In the past, a traditional IPO was the only way to go. But now, Spotify and Slack have demonstrated there is another option to consider. The direct listing has many advantages over an IPO and will likely be used by more companies in the future.
A direct listing makes sense for any company that wants to benefit from lower costs, no dilution to existing shareholders, market-based pricing of shares, equal access for all buyers and sellers, and no lockup period.
On the other hand, a company that needs to raise additional capital to fund future growth is not a good candidate for a direct listing. Also, a company that’s not well-known and really needs the publicity that comes with a pre-IPO roadshow may not want to choose this route.
If you’re a chief executive of a company that’s planning to go public, a financial advisor with experience with direct listings can help you decide which path is correct for your firm, investors and employees. And if you hold shares in a firm that’s planning a direct listing, it makes sense to discuss the implications for your personal financial plan with your wealth manager.
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