When taking a company from private to public, most choose the route of the initial public offering (IPO) — where a company hires an underwriter to help offer shares to public investors.
While popular, the IPO is not the only way for a company to go public. Lately, another type of offering is becoming more common: the direct listing.
Before explaining what exactly a direct listing is, let’s go through what constitutes an initial public offering.
With an IPO, a company will seek out an underwriter that will take on the risks of going public by purchasing all the outstanding shares of the company. Before buying the shares of the company, the underwriter will consult with investment firms and banks to help determine what the IPO price should be. This price is often calculated by determining the company’s future expected cash flows.
The underwriter then sells its shares to these investment firms and banks before the general public, who typically get access to the IPO on its final day of offering.
This underwriting service can become expensive as the intermediaries charge 3%-to-7% per share.
IPOing has its benefits for the company’s early investors and founders: they make a ton of upfront money. The problem is, however, that they only make money from the initial fundraising. Once the public markets have a chance to invest, those founders and early investors miss out on the gains.
We have seen two recent examples of this with DoorDash and Airbnb, which saw their stock prices soar after the IPO.
To avoid missing out on these gains and spending a ton of time in the pre-IPO phase, companies are now turning to the direct listing.
In a direct listing, a company will not issue new stock as is done in an IPO. The company’s stakeholders will put up their own shares, allowing themselves to take advantage of an increased company valuation without having to pay an underwriter or dilute their own remaining shares.
There are downsides to a direct listing, of course. While the services of an underwriter are expensive, they do help determine an offering price that has support from top investors and should hold up in public markets. Lesser-known companies may also have to do the “marketing” to get their name out there and prove to investors that they are a worthwhile investment.
Before the recent direct listings of Slack and Spotify, the IPO was the way to go for large, well-known companies. In September, we saw Palantir and Asana go public through a direct listing, struggling early on as their services aren’t so mainstream. Months later, however, they have seen dramatic gains.
Roblox, which hosts an online gaming platform, was considering an IPO before seeing shares of DoorDash and Airbnb soar post-IPO. Now they are planning to do a direct listing in February.
Another non-IPO way to go public that became trendy in 2020 is through special-purpose acquisition companies, a.k.a. “SPACs.” Private companies can merge with a SPAC, which are already public, and skip all the SEC filing and other IPO-related processes that slow things down.
Whether it be through a direct listing or a SPAC, private companies are finding unique ways to have their cake and eat it too when it comes to going public.
It’s hard to see the traditional IPO going away anytime soon. But with these methods becoming more and more appealing, the private-to-public process we all know and love may start losing its luster.