Direct Listing vs. IPO: Which is Better?
Insight provided by Ivana Korusiakova, originally published on March 29, 2020.
When we think of an Initial public offering (IPO) we think of new and innovative companies, banks, and the NYSE bell ringing — but as we move further into 2020, we may see fewer and fewer banks being involved in this listing process. Unicorn companies have been electing to move to the cost-saving strategy of direct listing, but it may affect the stock’s performance once it hits the public market. There are pros and cons to both options, but this article will be dedicated to highlighting and exploring the differences between an initial public offering and a direct listing.
An IPO refers to the process of offering shares of a private company to the public on a stock exchange. This allows the public to own shares of the company and allows the company to raise capital from public investors and institutions. When a company is planning an IPO, it typically selects an underwriter and chooses an exchange it wishes its shares to be issued on. A few examples of exchanges include the New York Stock Exchange (NYSE), which is an auction market, or the NASDAQ, which is a dealers market. A new trend that has been adopted by recent unicorns — private companies valued at $1 billion or more — going public is the direct listing method. This trend allows companies to forgo an underwriter and go straight to market.
The main difference between the initial public offering method and direct listing method is the underwriters. Underwriters work closely with the company throughout the process including helping price the shares, meeting regulatory requirements, buying available shares from the company and selling them through distribution networks. This network includes investment banks, broker-dealers, and stretches to institutional companies and mutual funds. Before the IPO, the hired investment bank will take the company on “roadshows.” Roadshows allow the company going public to be introduced to institutional investors to increase interest in the stock. This allows the bank to set a realistic price that will benefit the soon-to-be public stock. Underwriters also provide a guarantee of sale for a specified number of stocks once it hits the market. All these services come at a cost with underwriting fees ranging from 2% — 8% of the offering (how many shares the bank has sold). The bank is earning more money with every share sold, guaranteeing that at least some of the company’s shares will be bought. With this method, a company avoids the possibility that its shares are not bought once listed on the public market.
Companies that go public via a direct listing do so for various reasons; they may lack the capital to pay banks to underwrite the offering or they may not want to dilute existing shares by creating new ones in the process, which is why this process is becoming more common. When a company goes public, it is selling shares of its equity. In other words, by going public, a company’s current owners are giving up partial ownership of the business and, in turn, are expected to act in the interest of the shareholders. The more diluted with new shared this ownership becomes, the less control over the company the initial owners maintain. This low-cost option also comes with risks that are not present in an IPO. For example, there is no guarantee of sale of shares once the company is public, nor is there defense by large shareholders against volatility in share price.
A company that recently took the cost-cutting approach and issued shares directly to the market was Spotify Technology S.A. (Ticker: SPOT). Spotify took the direct listing approach seeking greater liquidity and allowed existing shareholders to sell directly to the public while ensuring transparency. After Spotify was successful with this approach, the New York Stock Exchange filed paperwork on November 26th, 2019 to allow companies to raise capital as part of direct listing. Slack also chose to go straight to market instead of hiring an underwriter. These changes are just a few of the shifts we’ve seen in the finance industry over the past few years. Valuations have been increasing, private equity and venture capital funds have been thriving, and the public offering process has been challenging the status quo and perceived norms. Finance has evolved and innovated and looking at the new changes makes the public excited to see where the industry is heading moving into the new decade.
Hayes, Adam. “Learn About Initial Public Offerings (IPOs).” Investopedia, Investopedia, 5 Feb. 2020, www.investopedia.com/terms/i/ipo.asp.
Seth, Shobhit. “The Difference Between an IPO and a Direct Listing.” Investopedia, Investopedia, 29 Jan. 2020, www.investopedia.com/investing/difference-between-ipo-and-direct-listing/.
Clark, Kate. “NYSE Proposes Big Change to Direct Listings.” TechCrunch, TechCrunch, 26 Nov. 2019, techcrunch.com/2019/11/26/nyse-proposes-big-change-to-direct-listings/.
Lev-Ram, Michal. “Direct Listings Are All the Rage in Silicon Valley. Here’s Why VCs Favor Them Over IPOs.” Fortune, Fortune, 22 Jan. 2020, fortune.com/2019/09/26/what-is-a-direct-listing-vc-ipo/.
Ivana Korusiakova is originally from Carmel, New York. She is a Business Administration major with a dual focus in Accounting and Finance along with a Bachelor of Arts in Economics. Ivana spent her summer in Boston as a Financial Services Assurance Intern at Ernst & Young. She considers herself to be hardworking and intellectually curious which allowed her to explore different organizations within the business school. Ivana serves on the Executive Board of the co-ed business fraternity, Alpha Kappa Psi, is an ambassador to both the Career office as well as to Dean Merrill-Sands and works closely with the Finance Department as a TA. She is also heavily involved in the Atkins Investment Group and serves on the executive board as the Vice President of External Affairs and Consumer Discretionary sector leader. Ivana hopes to combine her passion and knowledge of the public markets with the various incredible opportunities in the Rines Angel Fund to learn more and continue to be inspired by her accomplished peers in Paul College.
