Spotify did a direct listing in 2018 and very recently Coinbase did the same too!

In this thread, we are going to cover everything about Direct Listing!

Intro
Process
Pros & Cons
Why Direct Listing
Examples
Who can prefer this route
Conclusion

What is Direct Listing?

Direct Listing or Direct Public Offering (DPO) is the direct listing of shares of a company on the recognized stock exchange

The company becomes public by listing on a stock exchange without selling shares directly to the public

Existing shareholders such as PEs/VCs/Angel Investors, employees are able to sell their shares on listing (not obligated though)

Since there is no underwriting, DPO doesn’t need investment banks & underwriters(as no primary or secondary underwriting) like traditional IPO

Before the highly tracked/talked direct listing of Spotify in April 2018, direct listings were a relatively unutilized and unknown path to becoming a public company.

Market Watch identified only 11 direct listings in the 20 years prior to Spotify’s direct listing

In DPO – There’s no setting a price range, settling on a per-share sale price (but a reference price is determined + published by the exchange), going on roadshows with investment bankers to woo investors, or pre-IPO placement (selling shares to big investors)

Process –

3 Stages –

Preparation
Compliance Filings
Selling the Offering

Preparation – The decision on what security to sell; preparation of the document that describes the issuer and the offering; Preparation of legal documents for the offering and others.

Compliance Filings – Offering documents; specimen security; formation documents; attorney opinion and other financials submitted to the securities regulator

Selling the Offering – After approval from the regulator, the offer is sold

Advantages –

No dilution of ownership as no new shares issued

Avoid Hefty Fees to IBs making the overall issue expenses lower

Indirect cost savings of not selling the stock at a discount

Greater liquidity for its existing shareholders, without raising capital itself

No restrictions imposed (Standard lock-up agreements that prevent certain shareholders from selling their shares, typically for 180 days after the IPO to prevent volatility)

Provide unfettered access to all buyers and sellers of its shares (everyone can buy/sell)

More Fair and transparent as their employees (with shares), early investors, and founders can begin trading their shares immediately

The market forces set the equilibrium price without any manipulation (price stabilization measures) by underwriters.

Many direct listing participants who are for this technique say that this process is fairer because retail investors have the same opportunity as large institutional investors to buy and sell shares

Disadvantages –

Since underwriting not involved, more initial volatility is expected

DPO doesn’t raise capital for the firm(not recommended for firms that need capital. They can do secondary offering post DPO but the funding will be delayed as DPO has to be done first)

Relationship with Investment Banks – IBs typically bundle analyst coverage with other businesses. If a firm hires a top IB to take them public with a normal IPO, the IB is mostly going to have its analyst that covers the industry follow the stock, at least for a while

Marketing – Traditional IPOs have investment banks, underwriters (connected with institutional investors), and roadshows (where IBs help market the issue, market the IPO story, and showcase the management team). This helps in the proper marketing of IPO

In traditional IPOs thanks to IBs and underwrites, the issue gets marketed widely and also gets access to a much wider breadth of investors, especially those who move serious money. In DPO, that is not possible as it is direct and doesn’t involve these intermediaries.

In a traditional IPO, companies spend significant time with their investment bankers’ research analysts that will cover the company and its stock following the IPO. In DPO, this is not present

No Price setting – The price is completely at the hands of the market forces

Allocation – Companies can’t cherry-pick investors they want to allocate shares to. In a normal IPO, companies have a say in the allocation of shares and are able to place the shares with long-term, famous institutional investors which itself acts as a marketing tactic

Liquidity – Since it is unclear who will buy and sell, the liquidity has to be created for the shares on the first day of trading. An illiquid market on the first day of trading could result in negative consequences for the stock price.

Accordingly, companies need to spend a lot more time educating their insiders, including employees, about the direct listing process and how to sell shares, if they so choose, immediately after the stock begins trading

Lots of heavy lifting by management to educate investors – In the absence of Investment banks and Underwriters, the company’s management team has to take control and run the investor education process to make as many investors aware as they can about the company

Why a Direct Listing?

Every company is unique and hence it will be tough to generalize.

Let’s take the case of Spotify and how a Direct listing solved its objectives.

Spotify’s objectives –

No need for additional capital

Management believed that the direct listing process was more fair and transparent than a traditional IPO

As a well-known brand used by millions of people, Spotify did not require as much publicity to make potential investors aware of its listing

Despite these advantages, Spotify was worried that trading would be highly volatile without an underwriter to stabilize prices.

Examples of Direct Public Offering (DPO)

Spotify (2018)

Slack (2019)

Airbnb (Was considering a direct listing but instead went for traditional IPO and raised USD 3.5 Billion)

Most recently – Coinbase too did a direct IPO

Which type of companies can do a Direct Listing

Quite successful in the private capital markets

No immediate need for funding

Firms that have a large/diverse shareholder base, recognized brand, good scale, and a relatively easily understood business model

Evolving Perspectives on Direct Listing

Topic 1 – Volatility & Volume

Relatively low volatility + high volume of Spotify’s and Slack’s shares in opening days of trade reduced concerns regarding the model. But there are very few examples of direct listings to conclude

Topic 2 – Investor Education

Good shows by Spotify and Slack have inspired greater confidence in companies to complete a direct listing without a traditional underwriter-organized “roadshow” and using alternative forms of investor education activities

Topic 3 – Pricing

There has been growing interest by some firms and their pre-IPO shareholders in avoiding an IPO that trades up materially from the price sold in the IPO, as this is evidence of “money left on the table” by the seller

Conclusion –

There are positive implications of direct IPOs for early-stage investors and the whole private investing ecosystem as it helps them with faster, leaner, and efficient exits.

However, there are cons too such as low liquidity, less awareness for companies that are not well known, illiquidity and hence direct listing benefits will be case to case-specific.

There are not many examples that we can generalize.

Sources –

Harvard Law school of corporate governance article on Spotify

Renaissance US IPO market 1Q 2018 quarterly review letter

Inc

Crunchbase

brainsfeed

The balance

a16z

IPOhub

MONDAQ

TechCrunch

Fenwick & West Site

TD Ameritrade article on DPO

Cutting Edge Capital’s note on DPO

All our research here. | Our complete media coverage here.

Disclaimer

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