Guide to Direct Listings: How They Work & How They’re Different From IPO

By Laurel Tincher · March 21, 2022 · 5 minute read

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Guide to Direct Listings: How They Work & How They’re Different From IPO

When you hear of a company “going public”, they might be doing so through a direct listing.

Direct listings, also known as the direct listing process (DLP), direct placement, or direct public offering (DPO), have existed for some time, but in December 2020 the SEC revised the rules around this action, allowing companies to raise capital during a direct listing. The New York Stock Exchange had previously experimented with allowing the raising of capital during direct listings of companies.

What is a Direct Listing?

A direct listing is one method by which a company can list shares of stock on a public exchange such as the New York Stock Exchange (NYSE) or Nasdaq, also referred to as going public.

The other way is through an initial public offering, commonly referred to as an IPO.

Direct Listing Example

Some companies that have recently had direct listings are ​​Asana, Palantir, Thryv, Roblox, SquareSpace, and ZipRecruiter.

Initial Public Offering

When a company offers shares of stock to the general public for the first time, it’s known as an initial public offering (IPO).

Before an IPO, a company is “private,” which means that shares of stock are not available for sale to the general public. Also, a private company is not generally required to disclose financial information to the public.

To have an IPO, a company must file a prospectus with the SEC. The company will use the prospectus to solicit investors, and it includes key information like the terms of the securities offered and the business’s overall financial condition.

IPO Example

Companies that have gone public with IPOs include Bumble, Rivian, JD Logistics Inc, Volvo, BioNTech SE, and Zoom Video Communications Inc.

Direct Listing vs 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.

How a Direct Listing Works

A direct listing is fairly straightforward. If a private company is interested in going public but isn’t necessarily looking to raise additional capital, they 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. Holders may include investors, promoters, and employees.

By choosing a direct listing over an IPO, a company can avoid using an underwriter, which saves money. Further, because no new shares are created with a direct listing, existing shares won’t get diluted. Stock prices are determined by the market, according to supply and demand. (For this reason, the more recognizable the company, the more potential there could be for investor interest in its shares.)

How an Initial Public Offering Works

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.

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 is 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.

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Pros and Cons of Direct Listings

There are both benefits and downsides for companies and investors when it comes to direct listings vs. IPOs. This chart outlines the main points, which we delve into below.

Pros of Direct Listings

Cons of Direct Listings

Less expensive than an IPO Potential for initial volatility
No lock-up periods Risk that shares won’t sell
Liquidity for existing shareholders No help from underwriters
No stock price guarantee

Pros of a Direct Listing

A direct listing has some benefits for both the company and shareholders.

✔️ Less expensive than an IPO for the company

Unlike IPOs, direct listings do not require underwriters, since no new shares are being created. Typically, an underwriter charges a percentage fee of between 3% and 7% per share. This can add up to hundreds of millions of dollars. In addition, underwriters often purchase shares below their decided-upon market value, so companies don’t receive as much investment as they may have had they sold those shares to retail investors.

✔️ No lock-up periods for shares

IPOs are also subject to lock-up regulations that a company may want to avoid. 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 required in order 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 when it comes to direct listings.

❌ Potential for initial volatility

With an IPO, underwriters help bring in investors and can help avoid volatility during and after the shares get listed. A direct listing proceeds without that assistance.

❌ Risk that shares won’t sell

With a direct listing, the amount 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 with marketing and sales

Underwriters provide guarantees, promotion, and support during the listing process. Without an underwriter involved, the company may find that shares are difficult to sell, there may be legal issues during the sale, and the share price may see extreme swings.

❌ No guarantee of stock price

Just as there is no guarantee that shares will sell, there is also no guarantee of stock price. In contrast, having an underwriter can help manage potentially extreme price swings.

What to Know About Investing in a Direct Listing

As with any potential investment, interested investors need to do their own research on a company and truly evaluate it before buying in.

You’ll want to look at a balance sheet and other financials, learn as much as you can about the management team, take a broad view of the competitive landscape, and review the company’s prospectus. The more background you get on the company, the more comfortable you will feel with your decision.

The Takeaway

Direct listings are an appealing alternative to IPOs for private companies who want to go public, thanks in part to lower costs and reduced regulations. A direct listing may also be appealing to retail investors who want to purchase shares from companies that are going public.

For investors looking to keep up on the latest IPO and direct listing news — and possibly invest in IPOs — the SoFi Invest® online stock trading app can be a useful tool. The investing platform lets you research and track your favorite stocks, and view all your investing information in one simple dashboard. With a few clicks on your phone, you can buy and sell stocks, trade cryptocurrencies, ETFs, and other assets.

Find out how to get started with SoFi Invest.

FAQ

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.

What companies are direct listing?

Over the years there have been many companies who did a direct listing, including Ben & Jerry’s, Spotify, Slack, ​​Asana, Palantir, Thryv, Roblox, SquareSpace, and ZipRecruiter.

Is a direct offering good for a stock?

Since direct listings bypass the middleman and eliminate the need for underwriters, they can be less expensive for a company vs. IPOs.


Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

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