Direct Listing IPOs: what, why, who, and how?
2019 as the “Blockbuster Year for Tech IPOs”
The venture ecosystem was buzzing with excitement in the lead-up to 2019, touting it as the “Blockbuster Year for Tech IPOs” when startup behemoths like Uber, Lyft, Slack, Pinterest, and Airbnb were rumored to go public.
However, while the size of IPOs is growing, the number of IPOs has stagnated or declined.
Why? Because more and more money is flowing to startups via private fundraising rounds; while companies historically sought IPOs as a means to raise large sums of money, they now can (and do) get that capital from private investors rather than from the public market.
In fact, the median amount of funding raised prior to tech IPO has grown steadily from $64M in 2012 (the year Facebook IPO’d) to $239M today.
Having more cash on-hand allows companies to stay private longer. And even beyond the appeal of easy cash, staying private allows startups to make longer term, riskier decisions without the short-sighted scrutiny of hitting quarterly targets—an argument Elon Musk made best.
Consequently, the median time between first funding and IPO for VC-backed tech companies that went public rose from 6.9 years (for 2013 IPOs) to 10.1 years (for 2018 IPOs).
Companies are now older and larger at IPO than they were pre-Y2K.
The primary purpose or goal of IPO’ing is macro-shifting. IPOs are becoming less about companies raising capital and more about private investors seeking an opportune exit, including when they feel that returns have maximized.
And now, because of that, we are seeing a slow but momentous rise in an alternative form of going public: the Direct Listing IPO.
Direct Listing IPO: what is it?
The process of going public can take many forms. Most companies follow a “traditional IPO” which involves hiring bankers to execute off a tried-and-true playbook.
However, some private companies prefer to mix and match various tradeoffs to create a unique IPO process. Google, for example, attempted to go rogue with their Dutch auction IPO in 2004.
The direct listing IPO is just another such variation on a theme. To understand the difference, WSJ put it succinctly:
In a direct listing, a company bypasses the traditional underwriting process, which involves lining up investors ahead of time and selling shares at a set price, and instead lets the open market play a greater role in setting the price.
No money is raised for the company and for that reason direct listings are rare. Spotify is the only large company that has done one, debuting last year on the New York Stock Exchange.
The below matrix visualizes the use cases for traditional vs. direct listing IPO:
Direct Listing IPOs: why do it?
The ‘pros’ of doing a direct listing:
- No dilution of ownership—no new shares are offered, so existing shareholders retain more control
- Quicker process—there are no middle-person underwriters sitting between the company, the existing shareholders, and the public
- Less expensive—while there will still be some financial advisor costs, there is no underwriter fee (~3–7% of gross proceeds raised from initial listing)
- Capture first-day upside—historically, companies experience an avg. of 10–20% share price increase on the first day of trading; in traditional IPOs, underwriters sell new shares to institutional investors before the public listing and therefore capture that upside, but in direct listing, the current shareholders directly capture that upside
- Greater liquidity—existing private investors can cash out at any time without the 90–180-day ‘lock up’ period of traditional IPOs
- More equitable—in traditional IPOs, only large institutional investors are able to purchase shares directly from the underwriter, but in direct listing, all investors (retail or large institutional) have equal access to purchase shares the moment stock becomes public
- More transparent—the opening stock price is completely subject to market demand, which can be more value-driven than prices set by underwriters who engage in price stabilization activities
The ‘cons’ of doing a direct listing:
- More risky—there is no investment bank to ensure a favorable opening stock price and act as a safety net against market swings
- No funds raised—existing shares are directly listed, but no new funds or capital are raised
While the option to direct list has always existed, Spotify is the only large company to truly do it (although Slack has recently filed for a direct listing IPO). This is largely because there are so many unknowns; the sample size is still ‘one’.
Direct Listing IPOs: who will do it?
A direct listing IPO is attractive in certain circumstances.
Most notably, it makes most sense for ‘decacorns’—i.e. unicorns valued above $10 billion—with high-profile name recognition (thus alleviating the risk of not having underwriters to ensure valuation realization) and plenty of cash on-hand.
The startups with upcoming IPO plans that best fit this mold are Airbnb and Slack. But still, there is some skepticism:
- Airbnb, with a historical lack of employee liquidity, risks a first-day employee sale stampede that could deflate share price
- Slack, a B2B product, does not carry the same household recognition that Spotify, Airbnb, or other B2C products have
If Airbnb continues to pursue a direct listing, don’t be surprised to see a major secondary financing to allow early employees to cash out. And in Slack’s case, we finally understand its unprecedented DTC marketing campaign…
Direct Listing IPOs: how is it affecting venture?
Historically, companies did an IPO much earlier in their growth lifecycle:
Versus today, VC-backed startups are reaching more mature and increasingly saturated states of valuation prior to IPO:
The dark reality of this trend is that private investors (i.e. the 1%) are capturing more and more of overall market growth, whereas public investors (i.e. the 99%) are being left with more fully realized asset options. Per TechCrunch:
Taking a company public is also one way to tackle income inequality, which has worsened as more private companies’ investors — already the wealthiest investors in the world — have enjoyed near exclusive access to companies during some of their fastest growing years.
In response, SEC Chairman Jay Clayton is attempting to democratize access to private investing, which could have interesting implications for VC-LP dynamics.
Regardless, as long as private markets are lavishly generous and public markets are somewhat volatile, founders looking for capital will most sensibly approach growth by raising a ton of money in the private market and then quietly liquidating via direct listing later down the road.
Had Facebook — which, in 2012, was not in need of capital, had high brand recognition, and did not need much underwriter involvement — been born two decades later, perhaps it would have stayed private longer and pursued a direct listing IPO.
Matt Levine depicts the evolution well:
The IPO process is going through [change]: It used to be that, if you wanted to go public, there was one way to do it. Now there are two. But the choice creates the possibility of more choice, of unlimited customization, of tweaking each feature to get exactly the tradeoffs you want.
Not only can we expect to see more direct listing IPOs, but we can expect a greater variety of IPO playbooks in general.
2019 as “The Game of IPOs: Series Finale”
A common criticism of venture capitalists is their opaque and seemingly unjustifiable process of valuing startups — are they accurate? As companies take the public stage, we get to watch large-scale supply and demand forces in action. According to Pitchbook:
[Lyft]’s rocky IPO reception combined with Pinterest’s discouraging initial pricing has raised questions around whether lofty private market valuations will be validated by investors in the public markets.
With each high-profile IPO of 2019, public and private investors eagerly standby as the drama of immediate valuation validation unfolds. As my friend rightly quipped: “What is the stock market but the ultimate place for fan theories about the futures of various business entities?”
And: “Of course, the season finale will be the Uber IPO.”