Direct Listing

How Does a Direct Listing Work?

The traditional initial public offering (IPO) model has been disrupted by the emergence of direct listings, in which a company starts selling shares directly to the public.

The direct listing process is straightforward, as the company’s shares begin trading on an exchange, with no shares pre-negotiated and sold to institutional investors at a designated price.

Companies that opt for the direct listing route tend to be already well-funded (i.e. backed by more than enough capital) – therefore, there is no need for these companies to raise further capital through an IPO.

What are Recent Examples of Direct Listing?

In particular, technology startups have been leading the movement towards going public through direct listings as opposed to traditional IPOs.

• Spotify (NYSE: SPOT)
• Slack (NYSE: WORK) – Side Note: Acquired by Salesforce in 2020
• Palantir (NYSE: PLTR)
• Asana (NYSE: ASAN)
• Coinbase (NASDAQ: COIN)

But at the end of the day, direct listings and IPOs achieve the same objectives:

• Public Listing → Private Companies Get Listed on a Public Exchange (e.g. NYSE, NASDAQ)
• Institutional and Retail Investors → Equity Ownership Shifts from Insiders (e.g. Management, Employees, Venture Capital Firms, Growth Equity Firms) to the Broader Institutional and Retail Market
• Liquidity Event → Liquidity Event for Existing Owners of Equity (e.g. Venture Capital Firms)

What are the Benefits of a Direct Listing?

The trend of direct listings is expected to persist, especially considering the number of well-capitalized start-ups that will soon be going public.

So, why are direct listings growing in popularity as an alternative to traditional IPOs?

Following an IPO, there is a so-called “IPO pop” in which the shares of a newly listed company surge on the first date of trading.

In hindsight, the uptick in price is viewed by many as a missed opportunity to have:

• Set a Higher Issuance Price Per Share
• Raised Greater Amounts of Capital in the IPO

If an IPO was priced “correctly,” theoretically, there would be no significant share price movement.

The root cause of the criticism stems from the incentive structure of investment banks, where banks will pitch the IPO to raise investor participation and capital.

However, if the shares of the company hypothetically were to remain completely unchanged post-IPO, the returns to the institutional investors are zero – i.e. the investment banks’ clients would be disappointed in the lackluster returns and be unlikely to partake in future IPO offerings.

Learn More → Initial Public Offering (IPO)

Criticism of Traditional IPO Process: Bill Gurley

Prominent venture capitalists, most notably Bill Gurley, have criticized traditional IPOs for underpricing to help clients obtain greater returns once shares begin trading – frequently referencing IPO statistics gathered by Professor Jay R. Ritter.

In the early 2000s, the average IPO would trade up around 20% on the first day, whereas nowadays, the figure has expanded to around 50% for high-growth technology companies that go public.

^{Bill Gurley, IPO Perspectives (Source: Above the Crowd)}

Certain investment banks also take on the risk of selling all shares, which can compel them to lower the offering price to ensure all shares are sold, so they’re not left holding onto too many unsold shares.

Direct Listing vs. IPOs: What is the Difference?

Companies may choose to go public via a direct listing due to:

• Anti-Dilution – For companies with enough capital and just seeking to get listed, the direct listing route avoids the issuance of new shares (and dilution to existing shareholders)
• Immediate Liquidity – In the traditional IPO, there is a 180-day lock-up period for shareholders before shares can be sold, but in a direct listing, existing shareholders can sell their stake starting on the first day of trading
• Supply/Demand Structure – Rather than establishing a fixed pricing range as done in an IPO, a direct listing resembles an unrestricted auction where the market truly sets the price

Significant amounts of money are also saved in a direct listing by not having to pay IPO fees to investment banks – in part due to the shorter, more efficient process.

However, investment banks are still hired in direct listings, but the degree of involvement is limited to general advisory and oversight.

What is the Dilutive Impact of Direct Listings?

The dilutive impact is kept to a minimum in a direct listing, since no new capital is raised – albeit new regulations have changed the rules regarding new capital raising.

Historically, direct listings were not considered a viable replacement for IPOs due to the fact that new capital could not be raised.

But the SEC recently announced that companies undergoing a direct listing can now raise capital, helping build the case that direct listings are a preferable alternative to traditional IPOs.

What are the Risks of Direct Listings?

Since direct listings are relatively new, the process can be riskier, especially for companies that lack the proper guidance on legal considerations and other complexities.

While this risk pertains to both IPOs and direct listings, there is no assurance that the newly public company’s shares will be priced “correctly” or sufficient numbers of shares are sold.

In traditional IPOs, the share price is pre-negotiated upon gauging investor appetite before the company goes public.

By contrast, direct listings are priced solely on supply and demand on the date of listing – i.e. resulting in an unpredictable reaction and more volatility.

Companies going public through a direct listing miss many benefits of IPOs and working closely with investment banks, such as:

• Access to Network of Institutional Investors
• Other Product Groups (e.g. M&A, Debt and Leveraged Finance)
• IPO Process Improved from Decades of Iterations
• Guidance from Capital Raising Specialists