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When you hear of a company going public, one route is via an initial public offering, or IPO — but a company can also go public through a direct listing, where no new shares are created and underwriters are not required.
Direct listings, also known as the direct listing process (DLP), direct placement, or direct public offering (DPO), are a way for companies to raise capital by selling existing shares without the complexity of engaging investment banks and other intermediaries.
While a direct listing is typically less expensive than an IPO and often has no lock-up period, there are risks in direct listing shares without the support of underwriters.
Key Points
• Direct listings allow companies to go public by selling existing shares without underwriters.
• Initial Public Offerings (IPOs) involve issuing new shares and usually require underwriters.
• Compared with IPOs, direct listings can be less costly and often avoid lock-up periods, but may involve higher risk.
• IPOs provide companies with support from underwriters, which can help stabilize share prices.
• Direct listings offer immediate liquidity for existing shareholders, allowing them to sell shares directly to the public.
What Is the Difference Between Direct Listings and IPOs?
A direct listing is one method by which a company can directly list shares of stock on a public exchange, such as the New York Stock Exchange (NYSE) or Nasdaq, without using underwriters to create new shares, as you might with an initial public offering (IPO).
While some listing choices involve selling shares of stock to investors, IPOs and direct listings have many differences. The main difference between the two is that with an IPO, a company issues and sells new shares of stock, while with a direct listing, shareholders sell existing shares.
Comparing the Direct Listing and IPO Process
The differences between using a direct listing vs. an IPO to take a company public are distinctive.
How a Direct Listing Works
If a private company is interested in going public but doesn’t want the hassle of working with underwriters, it may choose to do a direct listing. With a direct listing, anyone who owns shares in the company can sell them directly to the public once the new company is listed on a public exchange. Shareholders may include investors, promoters, and employees.
By choosing a direct listing over an IPO, a company can avoid traditional underwriting fees, which may reduce overall listing expenses, though substantial legal and advisory fees still apply. Underwriters fulfill multiple roles in the IPO process, including working with the fledgling company to meet regulatory standards and set the initial price per share. These are important steps, but not necessary if a new company is only selling existing shares.
Further, because no new shares are created with a direct listing, existing shares won’t get diluted.
How an Initial Public Offering Works
When a company offers shares of stock to the general public for the first time, it’s known as an initial public offering.
Before an IPO, a company is considered private, which means that shares of stock aren’t available for sale to the general public. Also, a private company isn’t generally required to disclose financial information to the public.
The IPO Process
To have an IPO, a company must file a prospectus with the Securities and Exchange Commission (SEC). The company will use the prospectus to solicit investors, and it includes key information, such as the terms of the securities offered and the business’s overall financials.
Initial public offerings are a popular choice for companies looking to raise capital. The company works with an underwriter (typically part of an investment bank), who helps navigate regulations and figure out the initial price of the shares. They may also purchase shares from the company and sell them to investors (such as mutual funds, insurance companies, investment banks, and broker-dealers) who will, in turn, sell them to the public.
Benefits of Working With an Underwriter
One benefit of working with an underwriter is the greenshoe option. This is an agreement that a company can enter into with the underwriter, in which the underwriter has the right to sell a greater number of shares during the sale than they originally intended to, if there’s a lot of market demand. This can help the company gain additional investment.
Working with an underwriter creates some security for the company, which is one reason so many companies go the route of the IPO.
Pros and Cons of Direct Listings
There are advantages and disadvantages for companies and investors when it comes to direct listings vs. IPOs.
Pros of a Direct Listing
Less Expensive Than an IPO for the Company
Unlike IPOs, direct listings don’t require underwriters since no new shares are being created. Typically, an underwriter charges a fee of 4%-7% of gross IPO proceeds. Depending on the scope of the IPO, these fees can add up to hundreds of millions of dollars.
In addition, IPO underwriters often purchase shares below their agreed-upon market value, so companies don’t receive as much investment as they may have had they sold those shares directly to retail investors.
Typically No Lock-Up Periods for Shares
If a company goes through an IPO, existing shareholders are generally not allowed to sell their shares to the public during the sale and for a period of time following the sale. These lock-up periods are commonly used in IPOs to prevent stock prices from decreasing due to an oversupply.
The direct listing model is essentially the opposite, in which existing shareholders sell their stock to the public and no new shares are sold.
Provides Liquidity for Existing Shareholders
Anyone who owns stock in the company can sell their shares during a direct listing.
Cons of a Direct Listing
There are also some potential drawbacks to direct listings.
Risk That Shares Won’t Sell
With a direct listing, the number of shares sold is based solely on market demand. Because of this, it’s important for a company to evaluate the market demand for its stock before deciding to go the route of a direct listing.
Companies best suited to direct listings are those that sell directly to consumers and have both a strong, recognizable brand and a business model that the public can easily understand and evaluate.
No Help From Underwriters
Underwriters provide guarantees, promotion, and support during the listing process. Without an underwriter involved, the company may find that its shares are difficult to sell, that there may be legal issues during the sale, and that the share price may experience extreme swings.
Lack of Price Stabilization
Underwriters for an IPO work toward stabilizing the price of the shares when they start trading on a public exchange, such as by enforcing a lock-up period and placing stabilizing bids in the market. Direct listing shares, in contrast, may experience much greater price volatility when they begin trading on an exchange.
This chart outlines the main points covered above.
| Pros of Direct Listings | Cons of Direct Listings |
|---|---|
| Less expensive than an IPO | Risk that shares won’t sell |
| Typically, no lock-up periods | No help from underwriters |
| Liquidity for existing shareholders | Lack of price stabilization |
The Takeaway
Direct listings may be an appealing alternative to IPOs for some private companies that want to go public, thanks in part to lower initial underwriting costs and a different regulatory path to listing. A direct listing may also be appealing to retail investors who want to purchase shares from companies that are going public.
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FAQ
Why would a company do a direct listing?
A direct listing offers a more direct path to going public on a stock exchange. The company doesn’t have to issue new shares, as only existing shares get sold in a direct listing. This eliminates the need for intermediaries such as underwriters.
Can anyone buy a direct listing stock?
Yes, investors can buy a direct stock listing as they would any other stock listed on an exchange. Once the shares begin trading publicly, investors can purchase them through a brokerage account just as they would shares issued through a traditional initial public offering (IPO). However, because direct listings typically don’t include underwriters stabilizing the stock price, trading can be more volatile in the early days.
Is a direct offering good for a stock?
Since direct listings avoid traditional underwriting arrangements, they can be less expensive for a company than IPOs. However, the lack of share pricing and sales support may potentially put the stock price and initial sales at risk. In addition, without underwriters helping to stabilize trading, direct listings may experience greater price volatility when shares begin trading publicly.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of losing principal. Key risks include, but are not limited to, unproven management, significant company debt, and lack of operating history. For a comprehensive discussion of these risks, please refer to SoFi Securities' IPO Risk Disclosure Statement. This is not a recommendation and does not constitute an offer of any securities for sale. Investors must carefully read the offering prospectus to determine if an offering is consistent with their objectives, risk tolerance, and financial situation. New offerings often have high demand and limited shares. Many investors may receive no shares, and any allocations may be significantly smaller than the shares requested in their initial offer (Indication of Interest). For more information on the allocation process, please visit IPO Allocation.
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