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 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.
Direct Listing vs. IPO
While somelisting 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 Does a Direct Listing Work?
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.
Pros and Cons of Direct Listings
There are both benefits and downsides 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 do not require underwriters, since no new shares are being created. Typically, an underwriter charges a percentage fee per share between 3% and 7%. This can add up to be in the 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. That’s because anyone who owns stock in the company can sell their shares during a direct listing.
Cons of a Direct Listing
• 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.
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.
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