Direct Listings: The IPO Alternative

Introduction

In April of 2018, Spotify made headlines in the finance world when it went public on the New York Stock Exchange. Instead of taking the conventional route of an initial public offering — where firms seek the services of investment banks as underwriters — Spotify chose to undergo a direct listing, an unconventional decision that many claimed could change the future of IPOs. With other notable companies like Slack and Palantir Technologies opting for a direct listing since then, it’s clear that direct listings have become an increasingly viable option amongst certain firms looking to go public.

What is a Direct Listing?

As the name suggests, a direct listing is when a company offers its shares directly to the public, without investment banks acting as intermediaries between the firm and potential investors. In a traditional IPO, investment banks play a major role in facilitating the process of a company going public. Banks that are selected to work on an IPO are responsible for determining a fair price for the shares of the company, generating investor interest in the company, and selling shares to institutional investors such as mutual funds and broker-dealers. In the case of direct listing, existing owners of shares simply sell at whatever price public investors are willing to pay.

Benefits & Drawbacks of Direct Listings

The most obvious benefit of direct listings is that they are cheaper. IPOs can be very expensive, as investment banks charge a fee for their services, often as a percentage of each share listed. This can amount to millions of dollars in costs, which is not ideal for companies who went public to raise funds in the first place. Direct listings, on the other hand, eliminate these costs significantly or entirely, as there are no services required from intermediaries.

The drawbacks can be significant as well. Firstly, the publicity and investor interest that IPOs generate are not afforded to firms who choose a direct listing. The “roadshow,” which is the process of investment banks pitching the IPO to potential investors, can be instrumental in getting a company to go public successfully. Without it, there is no guarantee that major investors will take any interest in the company’s shares. Direct listings can lack this strong support from institutional investors, which raises questions over the long term health of the company’s stock. As a result, directly listed stocks are more likely to suffer from volatility once they go public, as there are no large shareholders to stabilize the price, and no established pricing that comes with an IPO.

When is a Direct Listing Appropriate?

With so many possible downsides to a direct listing, the question is: what kind of company would opt for it?

Ultimately, direct listings are not right for everyone. One type of company that could benefit from a direct listing is a company who already has a strong brand presence and is very well known by the public. This eliminates the need for a roadshow, as retail and institutional investors alike will already have their eyes on the company’s stock. On the opposite end of the spectrum, smaller firms that can’t afford an IPO, or that want to set their own terms for the offering, may also find a direct listing attractive.