Complex Made Simple

IPOs getting old, clunky: Make way for direct listings

IPOs versus Direct Listings: Why public offerings and fundraisers are leaning away from underwriters to save money

IPO underwriters create and commit to selling a set number of shares, charge a fee per share anywhere from 2% to 8% $26 bn company Spotify sold 17% of their outstanding shares on the first day of their direct offering VC-backed IPOs underwritten by Goldman Sachs had, on average, a 33.8% first-day share price gain

We bid 2019 farewell with Saudi Aramco IPO-ing 2% of its shares on the Saudi exchange Tadawul.

Complex deals like this one, involving the largest, most valuable company in the world, need good underwriting, and all the bells and whistles that come with organizing a successful IPO.

But the trend is elsewhere and some of the biggest companies in the world are opting for direct listings (DLs).

IPO vs. Direct Listing 

Initial public offerings and direct listings are two methods for a company to raise capital by listing shares on a public exchange. 

IPO underwriters create and commit to selling a set number of shares, charge a fee per share anywhere from 2% to 8% with fees often totaling in the hundreds of millions per IPO that undermine capital raising.

Companies can choose a direct listing, also known as Direct Placement or Direct Public Offering (DPO), in which no new shares are created and only existing, outstanding shares are sold with no underwriters involved.

These companies may not have the resources to pay underwriters, or may not want to dilute existing shares by creating new ones or may want to avoid lockup agreements. Companies with these concerns often choose to proceed by using the direct listing process, rather than an IPO.

However, the zero- to low-cost advantage also comes with certain risks for the company. There is no support or guarantee for the share sale, no promotions, no safe long-term investors, no possibility of options like greenshoe (provision granting the underwriter the right to sell investors more shares than originally planned) and no defense by large shareholders against any volatility in the share price during and after the share listing.  

Going public with a direct listing

We begin with Reuters quoting Barry McCarthy, finance chief of music-streaming outfit Spotify Technology saying a direct listing is “just an IPO without the O”.  

McCarthy’s company, worth $26 billion in early December, used DL to go public in 2018. Typically, during a regular IPO 10-15% is sold. Spotify broke the mold being a massive tech-based consumer company to go the direct listing route. Spotify sold 17% of their outstanding shares on the first day of their direct offering.

And $12 billion workplace-messaging service Slack Technologies followed with a DL in 2019, sold 22% of their outstanding shares, and were the 5th lowest in volatility for massive tech IPO’s, according to Forbes.

McCarthy suggested in a panel discussion hosted by investment bank Goldman Sachs in October that the traditional way of going public was “chronically broken” – a sentiment shared by venture capitalists like Benchmark Capital’s Bill Gurley. Critics resent the underwriting fees paid to banks for IPOs and often chunky first-day stock-price gains, which suggest under-pricing.

A direct listing is not for everyone. One big limitation is that direct listings don’t raise new money, a problem for companies that need investment dollars.

Problem with Underwriters 

VCs believe that the underwriters, which in most cases are investment banks, price shares deliberately low so they can surge on the first day of trading. The surge benefits the institutional clients who buy at the low initial offer price and then flip their shares when the price goes up.

This underpricing of shares via IPOs means that companies receive less capital and early investors such as VCs see diminished returns. 

Research shows that in the past decade, VC-backed IPOs underwritten by Goldman Sachs had, on average, a 33.8% first-day share price gain. Some VCs now believe it’s hard to justify giving away millions of dollars in one day.  

As reported by Forbes, Colin Stewart of Morgan Stanley commented on this emerging DL phenomenon:

  1. Private markets are more robust and accessible than in the past. In the current market landscape the time to IPO’s is becoming longer and deal sizes are smaller. 
  2. Direct Listings may lead to an accelerated time line. In large cap companies Direct Listings may offer larger access to capital and can lead to lower volatility.
  3. There’s an emerging trend that institutional investors will be more familiar, comfortable and accepting of Direct Listings.