Hot technology startups have traditionally raised the cash they needed to break into the big time through initial public offerings. IPOs became synonymous with instant wealth for company founders and those lucky enough to buy those shiny new shares. Then music-streaming service Spotify Technology SA went a different route, going public through a method called direct listing. Why a direct listing? While Spotify didn’t need new cash, its investors wanted to cash out. Workplace messaging platform Slack Technologies Inc. followed suit last year and Silicon Valley buzzed with speculation whether Airbnb Inc. or a dozen other tech unicorns might be next. Little of what was predicted has come to pass, though, until now.
1. Is the direct listing surge finally here?
When 2020 began, IPOs had lost some luster because of a string of limping former unicorns — firms that had attained private valuations of $1 billion or more but stumbled after going public, Uber Technologies Inc. being the largest of them. Then the coronavirus pandemic hit and the economy plummeted, sapping appetites for innovation and risk. Airbnb, the highest-profile direct listing candidate at the time, first tapped the brakes on its plans to go public and then switched gears to a traditional IPO in which it would raise capital to offset the battering it took from the drop in travel. But in August, Palantir Technologies Inc. and Asana Inc. filed for direct listings and both are now planning their trading debuts on Sept. 30.
2. How are direct listings different from IPOs?
In an IPO, companies looking to raise funds in public markets hire investment bankers to stage a “roadshow”: the bankers make presentations in different cities, mostly virtually this year — to get investors excited about buying the new stock, and then underwrite the share sales. Banks often set the initial share price in an IPO at a discount below the expected trading range, with the aim of creating an attention-grabbing “pop” on the first day of public trading as new investors clamor for a hot new stock. In a direct listing, no new money is raised and no new shares are sold. Instead, private investors or employees who hold shares can just start selling them on the public exchange.
3. What’s not to like about IPOs?
The IPO “pop” may get attention, but it often irritates the founders of new companies and their existing shareholders. They complain that their bankers “left money on the table,” by deliberately setting the opening price too low as a way of rewarding the big investors they count on to create demand. Another reason to do a direct listing is to reduce bank fees. An IPO can cost a company 7% of the proceeds raised. By comparison, if a company does a privately placed offering of stock, it’s only paying a bank about 2%. And direct listings — until now — haven’t had lockup periods, a standard restriction in IPOs that limits large shareholders from selling their stakes for 90 days or more. That’s so that the market isn’t flooded with too many new shares at one time.
4. Which companies are right for direct listings?
Companies have been spending more years growing and raising private funds before going public. That means many have less of a need for new funds, and have a bigger existing shareholder base. Those investors want the liquidity that comes with trading on public markets and may frown upon the company diluting the value of their shares by issuing more of them. Asana, a corporate software maker started by Facebook Inc. co-founder Dustin Moskovitz, said its business stands to benefit from the shift to working from home. Palantir, the data-mining company backed by tech billionaire Peter Thiel, had toyed with going public for years. While each remains unprofitable, both see growth ahead without the need to raise new money, though Palantir has added a new twist.
5. Why is Palantir’s listing different?
Direct listings — as filing documents warn — can be volatile. Unlike in an IPO, investor interest isn’t verified through share sales ahead of the trading debut and there’s no “stabilization agent,” a role usually taken in an IPO by a bank working to make sure the newly public stock doesn’t swing wildly. IPOs also usually have an overallotment, or “greenshoe” option allowing the underwriters to issue more shares to help guard against massive price moves. Palantir decided to limit those risks by tacking on what amounts to a partial lockup period. Its investors will only be allowed to sell 20% of their holdings when the stock begins trading. The remainder will be subject to a lockup period that won’t lift until next year after Palantir has reported its 2020 fiscal results.
6. How are exchanges reacting to direct listings?
The New York Stock Exchange won approval in August from the U.S. Securities and Exchange Commission for a hybrid type of offering that would have the advantages of a direct listing and still allow a company to raise capital. In what the NYSE calls a primary direct floor listing, companies will be able to issue new shares. Unlike a traditional IPO, the new shares won’t be underwritten by banks or allocated to institutional investors the night before the listing. They will instead be sold on the day of the listing at an opening price decided by the market. When the stock begins trading, new shares will get priority over secondary ones. This will give companies a better chance at reaching their fundraising goals. An investor group has petitioned for further review of the decision by the SEC, which has put its previous approval on hold for now. Nasdaq Inc. had submitted its own proposal to the SEC to allow companies to raise capital in direct listings on its exchange.
7. Are IPOs dead?
Far from it. While GDP and employment have been walloped by the pandemic, capital markets have surged back and venture capital and private equity firms that have shepherded their portfolio companies to public markets are that much closer to getting their return on investment. August, with almost $21 billion in new listings, was the busiest month for U.S. IPOs since September 2014, when 36 companies went public raising $33 billion, according to data complied by Bloomberg. The three biggest-ever summer months for IPOs on U.S. exchanges were this June, July and August, the data show. Much of the activity has been driven by special purpose acquisition companies, or SPACs, which raise money in an IPO and then use those funds to buy a private company that wants to go public without the hassle of an IPO.
8. Will banks make money from direct listings?
Of course they will, though some will make more than others. Morgan Stanley and Goldman Sachs Group Inc. emerged last year as key proponents of direct listings. While companies going public get to skip underwriting fees with a direct listing, they still rely on banks as advisers. The primary adviser ends up with an amount on par with what the the so-called lead-left underwriter would collect in an IPO. It’s all the other banks on the deal that get less. In Palantir’s listing, Morgan Stanley secured the coveted role of sole adviser to the designated market maker, which facilitates the shares’ opening trading and helps determine prices. Goldman Sachs is one of 11 other bank advisers. Morgan Stanley is set to perform that same service in Asana’s listing, as it did for both Slack and Spotify.
The Reference Shelf
- An article on Palantir’s listing plans and snub to Silicon Valley.
- An examination of Asana’s financials.
- An article looking at how Slack’s valuation was estimated.
- A look at the mechanics of Spotify’s listing.
- The battle between banks for the fees in Slack’s direct listing.
- A profile of Slack’s chairman, born in a log cabin.
- The investor group petition seeking review of approval of NYSE primary direct floor listings.
- An article on the current status of direct listings and regulations.
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