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!
Pros & Cons
Why Direct Listing
Who can prefer this route
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)
3 Stages –
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
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
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)
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
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.
Harvard Law school of corporate governance article on Spotify
Renaissance US IPO market 1Q 2018 quarterly review letter
Fenwick & West Site
TD Ameritrade article on DPO
Cutting Edge Capital’s note on DPO
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