What a ‘Direct Listing’ Is, and Why Banks Are Nervous
What a ‘Direct Listing’ Is, and Why Banks Are Nervous
(Bloomberg) -- Hot technology startups have traditionally raised the cash they needed to break into the big time through initial public offerings. IPOs became synonymous with instant wealth for company founders and those lucky enough to buy those shiny new shares. But for some of the new generation of tech firms going public, one thing is very different: they don’t need the money. Music-streaming service Spotify Technology SA went a different route last year, going public through a method called direct listing and workplace messaging platform Slack Technologies Inc. followed suit. Airbnb Inc. has considered a direct listing as it weighs its options for going public.
1. How are direct listings different from IPOs?
Before an IPO, companies looking to raise funds in public markets hire investment bankers to stage a “roadshow”: the bankers make presentations in different cities to get investors excited about buying the new stock, and then underwrite the share sales. Banks often price the IPO at a discount below the expected trading range, which can create a “pop” in the first day of public trading as new investors start to buy shares. In a direct listing, no new money is being raised and no new shares are sold. Instead, private investors or employees who hold shares can just start selling them on the public exchange.
2. How is a price set for a direct listing?
In a direct listing, a so-called reference price is issued by an exchange, with some investors seeing it as a guide. It’s partly based on how the stock was valued in private markets. The reference price is just what the name implies; it isn’t the same at all as the offer price investors pay for shares in an IPO. The idea is for the market to determine the price, not the banks. Spotify, which was given a reference price of $132 a share, opened at $165.90 in its debut and fell 10% from that to $149.01 on its first day.
3. What’s the appeal?
For one thing, a direct listing avoids the IPO “pop,” which irritates many new companies and their existing shareholders, who often feel that their bankers deliberately set the opening price too low as a way of rewarding the big investors they count on to create demand. Another reason to do a direct listing is to reduce bank fees. An IPO can cost a company 7% of the proceeds raised. By comparison, if a company does a privately placed offering of stock, it’s only paying a bank about 2%. And listings have no lock-up. That’s the term for the standard restrictions in an IPO limiting large shareholders from selling their stakes for 90 days or more. That’s so that the market isn’t flooded with too many new shares at one time. In a direct listing, anyone holding shares can sell them immediately.
4. Why now?
Companies are spending more years growing and raising private funds before going public. That means many have less of a need for new funds, and have a bigger existing shareholder base. Those investors want the liquidity that comes with trading on public markets. But they don’t necessarily want the company diluting the value of their shares by issuing more of them.
5. What are the risks?
Direct listings -- as filing documents warn -- can be volatile. Unlike in an IPO, investor interest isn’t verified through share sales ahead of the trading debut and there’s no “stabilization agent,” a role usually taken on in an IPO by a bank working to make sure the newly public stock doesn’t swing wildly. IPOs also usually have an overallotment, or “greenshoe” option allowing the underwriters to issue more shares to help guard against massive price moves. Without a lock-up, large shareholders in a direct listing could potentially dump a lot of their holdings right away. But in any event, volatility was limited in both Spotify’s and Slack’s listings. A smooth start doesn’t guarantee a smooth ride forever: Spotify’s shares fell as low as $106.84 in December before rebounding, while Slack’s fell from the opening price of $38.50 to around $26 at the end of October.
6. Is this going to become a more common way to go public?
It might, though a lot of companies want to see other firms go first. Interest was high enough for a closed-door forum to be held for Silicon Valley firms in September in which the benefits of direct listing were hashed out. Goldman Sachs Group Inc. and Morgan Stanley have held conversations with at least a dozen clients about whether it could be an option for them, people familiar with the matter have said. Other banks are skeptical. Mostly, advisers feel that companies with big brand names may do well in a direct listing if they don’t need to raise more money. Still, if a direct listing stampede is coming, it hasn’t arrived yet. Between Spotify and Slack’s listing, at least 248 companies went public through traditional IPOs in the U.S. that raised $64.75 billion, according to data compiled by Bloomberg. Raising money is still important for many young firms.
The Reference Shelf
To contact the reporter on this story: Sonali Basak in New York at sbasak7@bloomberg.net
To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, ;Elizabeth Fournier at efournier5@bloomberg.net, John O'Neil, Michael Hytha
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