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May 14, 2021
Rather than going public through an IPO, more tech companies are opting for the direct listing, a process that tech firms such as Palantir, Roblox, Slack, Spotify and Coinbase have helped to standardize. In a direct listing, the company’s stockholders, but not the company itself, sell existing shares directly to the public. Instead of an underwriter who determines the price as with an IPO, in a direct listing the company hires a financial advisor who works in conjunction with the stock exchange to establish the opening price, based on buy and sell orders.
A direct listing is a liquidity event that does not fill the company’s coffers with cash. Shares are not allocated at a pre-established price. A direct listing does not have a lock-up period because it is based on shareholders selling their holdings. Only outstanding shares held by existing investors, promoters and any employees can be sold directly to the public. In other words, a direct listing allows the transfer of ownership from the company’s private investors to public investors, without raising new capital.
IPOs raise new capital as the company releases new shares to institutional investors before the launch. The shares are allocated to sell at a predetermined price, typically as high as investment bankers believe the market will bear, based on perceived interest from institutional investors. Bankers are incentivized to set the price high because they usually get paid a percentage of up to 7% of the total amount raised. Shareholders typically have a lock-up period of six to 12 months during which they cannot dump their shares on the market.
Companies that select the direct listing method have different goals than those that go for an IPO. They are not necessarily looking for capital. They instead aspire for other benefits stemming from being a publicly traded company, including boosting liquidity for their existing stockholders. In contrast, companies that choose the IPO aim to generate capital for expansion or funding.
Companies may also opt for the direct listing because it allows them to avoid the promotional costs of an IPO as well as its consultancy fees. IPOs entail costly roadshow tours to present the company to institutional investors and steeper investment banking fees. In addition, the direct listing is a much quicker process and entails lighter regulatory scrutiny.
By going the direct listing route, the founders of data analytics firm Palantir were able to implement more restrictions on voting power without the requirement of rigorous questions that the IPO process mandates. Opting for a direct listing effectively let the company diminish the level of scrutiny paid to its corporate governance framework. Palantir’s shareholder structure grants its founders control of the company, even if they hold as little as 6% of the firm.
Direct listings are not the right fit for every company. To succeed, a company must fit a certain profile. Because there will be no underwriter working for an investment bank on behalf of the company, the firm itself must be sufficiently appealing for the market on its own. In general, companies suitable for this method are those that are consumer-facing with a strong brand presence, have a business model that is easily understood and do not need a great deal of additional capital.
For example, Slack and Spotify, which went public through direct listing in 2019 and 2018, respectively, enjoyed solid reputations in the market beforehand. Both were broadly used, and the way they made money was easy to comprehend. These factors jointly increased the number of people interested in investing in the companies.
Capital market insiders say most companies will continue to opt for the IPO. The thinking is that the majority of companies will need the underwriters and their introductions to institutional investors. Also, investment banks often bundle analyst coverage into the underwriting process, and those pursuing a direct listing aren’t guaranteed any coverage.
In addition, underwriters offer companies an assurance of how much they are estimated to raise in advance of the IPO. Companies that pursue direct listings will not know how much they have raised until the shares start trading. Finally, another reason most companies may choose the IPOs is that mature private companies typically garner less investor buzz than a hot startup, so their chances of an outsized first-day trading jump are smaller.
On the other hand, venture capitalist Bill Gurley told CNBC that direct listings will almost certainly bring about the end of the traditional IPO. New York Stock Exchange President Stacey Cunningham called the direct listing a welcome improvement to the IPO arena that could help improve access for private companies to break into public markets.
Other finance experts add that the direct listing is a more democratic process in that individuals aren’t cut out of the chance to purchase at the lower offer price. “With a direct listing, it’s kind of more likely the opening price reflects the long-term value,” said University of Florida professor and IPO expert Jay Ritter, since no portion of the stock is being held back from trading and potentially changing the supply-demand market conditions.
Squarespace Inc has registered about 40 million shares for a direct listing, with shares to commence trading on the New York Stock Exchange May 19. ZipRecruiter just announced a finalized plan for a direct listing of certain class A shares with an effective direct listing date of May 26. Instacart, long rumored to be closing in on an IPO, is widely reported to be considering the direct listing route.
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