Since Spotify pioneered the method of direct listing in 2018, an increasing number of companies have opted for this alternative path to the public market. Slack, ZipRecruiter, Squarespace, Asana, Palantir, Roblox, Watford and Coinbase are recent examples.
And in September 2021, online data management company Amplitude and eyeglass retailer Warby Parker made their debuts on U.S. exchanges through direct listings instead of an IPO.
Despite forgoing the underwriting and marketing help of a routine IPO, these companies not only achieved success, but they also outpaced the S&P 500 in their time on the market, according to research from University of Florida finance professor Jay Ritter.
The basics
IPOs and direct listings are both methods for a private company to go public, or in other words, to list their shares on a public exchange.
Initial public offering: The more commonly used IPO method involves the creation and sale of new shares, which helps the company to raise capital from public investors.
Underwriters such as banks and investment houses are engaged to help conduct roadshows and persuade investors to buy stock in the company. They also establish the initial price at which the shares will trade, for which they charge fee as high as 7% of the amount of money raised.
Direct public offering: Popularly known as the direct listing, this is a liquidity event in which the company does not raise new capital. The company instead lists its shares on a public exchange without much help from banks or underwriters (more like advisers), and the shares begin trading at a price set through negotiations between the company and public investors.
The direct listing circumvents the steep fees of investment bankers associated with the traditional IPO. And there are no shares issued. The process only makes existing stock owned by employees and/or investors available for the public to buy.
Ritter’s research
University of Florida Department of Finance professor Jay Ritter compared the performance of eight of 10 companies that have used direct listings (except Slack and Watford, which were acquired) by comparing their stock prices at the end of the study period to the prices of the S&P 500 and the Renaissance Capital IPO ETF as a benchmark for IPOs overall.
Here are his research findings:
Direct-listing companies outperformed S&P 500: Ritter’s calculations revealed that the share values of the direct listing companies rose by 64.4% from their opening trading prices, while the S&P 500 had a 26.8% return and the Renaissance index rose 31.1% during the study period.
Direct-listing companies are high-profile: The fact that these companies were able to achieve success without underwriting and marketing support reflects that they are a high-quality group of companies.
Which companies are good candidates for the direct listing?
Not every company is suited to go for a direct listing. Only those that are well known to the general public and do not need to raise new capital should opt for this unconventional route.
Warby Parker is a good example of the type of company that can make the direct listing method work to its advantage through its strong brand profile. Similarly, Spotify and Slack were high-profile companies that reached unicorn valuation before their direct listings.
In general, the optimal company profile for a direct listing looks like this:
It is already widely familiar among the general public. As a direct listing circumvents the underwriting and marketing process, companies opting for the route have to have the stature to attract investors on their own.
It doesn’t need to raise additional capital to fuel growth. Listing directly on the exchange does not fill the company’s coffers with cash. For companies that do not need new capital and have solid revenue, that makes the direct listing viable. For instance, Warby Parker raised $245 million in August 2020 and apparently concluded it already had the capital it required by September 2021, when it went public by direct listing.
It doesn’t require the services of an investment bank. A direct listing candidate needs an easily understood business model that doesn’t necessitate a costly roadshow to draw the interest of investors. Here again we point to the example of Warby Parker, which did not need an investment bank while listing its shares on exchange as it already enjoyed a solid reputation in the market, its services were widely used and the way it makes money was easy to comprehend.
