Update: The New York Stock Exchange filed paperwork on Tuesday with the Securities and Exchange Commission to let companies going public through a direct listing to raise capital.
Here at Crunchbase News, we cover a lot of tech and tech-adjacent startups as they go public. The process by which they’ve done so has been pretty much the same: through an Initial Public Offering (IPO). But lately there’s been more and more talk of going public through a direct listing, so we thought we’d break down exactly what that means.
An initial public offering entails the sale of newly-issued securities to underwriters and their clientele, whereas a direct listing is more like a secondary sale of existing shares designed to give founders, prior investors, and vested employee shareholders a path to liquidity.
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Both ways of going public achieve the same thing (bringing a private company to public investors) but there are key differences between the two. Let’s explore.
What Is A Traditional IPO?
What we’ll call here a “traditional IPO” is the process through which most companies historically have gone public. The steps go something like this: File an S-1 with the Securities and Exchange Commission, set a goal of how much you want to raise with your IPO, set a price range of how much you want to sell each share for, settle on a price and sell a block of shares for that price to institutional investors, and then commence trading on the public markets.
On the first day of trading, investors watch closely to see what price the stock opens at when the market itself opens for trading, and what price the company closes at when trading closes.
Generally, it’s a good sign to see the company’s equity open above the price at which it sold shares during its IPO process. However, companies generally don’t want their newly-tradable equity to open too much higher than the set price, because that could mean money was left on the table (i.e. the company could have raised more money from investors by selling shares at a higher price) .
What Is A Direct Listing?
A direct listing is just what it sounds like: direct. It brushes off most of the pre-trading steps that traditional IPOs take and gets straight to trading. There’s no setting a price range, settling on a per-share sale price (though a reference price is determined), going on a roadshow to woo investors or selling a block of shares to institutional investors before hitting the market.
Conventional wisdom says that direct listings are best suited for companies that have a lot of brand recognition: If the majority of the public is familiar with your brand, you don’t need to put a lot of work into selling it. Conversely, if your company wants to go public but isn’t as well-known as, say, Spotify (perhaps more of a problem for B2B companies), a traditional IPO may be better.
According to Jay Heller, Nasdaq’s Head of Capital Markets, an ideal candidate for a direct listing is a well-known company that doesn’t have a need for capital, has a seasoned management team with an established track record, and is willing to give financial metrics and forecasts ahead of time.
Direct listings have benefits like no lockup periods (a time restriction preventing early shareholders from selling stock), but they also have challenges like liquidity and potential volatility, Heller said.
What Else Is Different?
A major difference between IPOs and direct listings is the role of banks. In an IPO, there’s a capital raise when banks commit to buying shares of a company at a set price, according to Heller. With a direct listing, banks aren’t acting as underwriters, but more like financial advisers.
“In an IPO the banks are setting them up on roadshows, working with investors,” Heller said in an interview with Crunchbase News. “In a direct listing, banks have no say on that…to get out and tell the story, it’s really on corporate’s responsibility to facilitate that.”
That makes it more challenging, Heller added. With an IPO, banks help a lot with generating interest from the investor community. With a direct listing, a company has to do that on its own.
“You need a shareholder base with a direct listing.That’s probably large and they have a desire to sell,” Heller said. “Because with a typical IPO, the company is offering a set amount of shares at a certain price. With a direct listing you really need your early shareholders to come in to the marketplace on day one to provide for liquidity, and that’s really tough.”
Execution on the day a company makes its debut on the public markets is very much the same for both direct listings and IPOs, Heller said.
Which Companies Have Listed Directly?
Not many companies, though obviously there have been some. Direct listings have been more in the spotlight recently because a couple of high profile unicorns went public that way. Spotify seems like it was the OG (though it certainly wasn’t the first) when it had a direct listing in 2018, and Slack chose to go the same route when it went public earlier this year. They aren’t the only ones, but may be the most visible. Nasdaq has been listing directly since 2006, Heller said, pointing to insurance company Watford Holdings as a direct listing on Nasdaq this year. There’s been talk of Airbnb (another well-known unicorn) doing a direct listing when it goes public in 2020, and startup executives and venture capitalists gathered to discuss the prospect of tech companies going public via direct listings earlier this fall.
A company that wants to go public should do its due diligence on its options, and really think about what it’s trying to achieve and the purpose of the listing. Is it trying to raise capital? Provide liquidity?
“It’s really do you need capital or do you not, and if you do need capital then a direct listing is probably not for you,” Heller said.
Nasdaq doesn’t have a preference either way a company goes public, Heller said, and it will support corporate pre-listing, the day of, and after it goes public. But companies need to do their research and choose the path that will set them up for success in the future.
“It’s not for everybody,” Heller said of direct listings. “But that doesn’t mean that everybody shouldn’t be asking the questions.”
Illustration: Dom Guzman