PRIMER: direct listings
IFLR’s latest free-to-read explainer looks at direct listings and how they differ from traditional IPOs
Direct listings have existed for a while as an alternate path to market, however, they have not been as widely used by companies as the more traditional IPO method. Recent success for direct listings such as Coinbase’s offering which debuted with an $85.8 billion market cap valuation in April could be a sign of things to come.
IFLR’s latest explainer looks at what direct listings are and what they offer, as well as the = regulatory challenges and the downsides of opting for this route in the capital markets.
“Today the conversation is no longer about IPOs, people want to know what are the other options that we have to access the market,” said Alexander Ibrahim, head of international capital markets at New York Stock Exchange (NYSE).
What is a direct listing?
A direct listing is when a company decides to offer its shares for sale to any investor without doing a public raise. Unlike a traditional IPO, the company does not conduct any underwritten offerings or booking building processes. “There is no investor roadshow, but there is an obligation of the company to create transparency for the investor,” said Adam Kostyál, head of European listings at Nasdaq. “Basically, you take away all lock ups and you allow trade of existing shares to the public market.”
Traditional IPOs requires a thorough book building process where the company identifies institutional and retail investors that are willing to buy into a company. There is a commitment to buy at a certain valuation. Therefore, to a large extent, a company can lock in investors prior to the opening of trade.
“With a direct listing you are basically telling the market that there will be a transaction. A transaction with the possibility to buy shares in the company,” he continued.
Are they any regulatory challenges?
At least in Europe, whether a company chooses to undertake a direct listing or a traditional IPO remains largely a commercial decision rather than a legal one. There aren’t any significant additional regulatory burdens by choosing one over the other.
“From our market perspective, we do not see any regulatory challenges with doing a direct listing,” said Kostyal.
A similar case is present for the UK.
“In terms of the fundamental conditions a company must satisfy to get access to the market, it’s broadly the same whether it is a direct listing or an IPO,” explained James Roe, partner at Allen & Overy.
Eligibility requirements for an IPO or a direct listing focuses on aspects such as a company’s share capital, its nature, its public cost, governance standards, track record, etc.
“What is potentially a real issue on a direct listing is the 25% free float requirement,” added Roe. “An IPO is a mechanism to increase the free float, and a company without sufficient free float may be unable to obtain a listing without an IPO.”
America takes the next step
While in Europe direct listings still do not involve capital raises, the US has started to experiment with this.
“A few month ago, we got the approval to offer to direct listings with capital raising,” said Ibrahim at NYSE. “So now we are offering this opportunity for companies to do a primary offering at the time of direct listings occur. So, this is an evolution of direct listings.”
This raises the question of why a company would choose to do a direct listing with a capital raise as opposed to a traditional IPO.
“The company wants access to capital, and they don’t want to go through the IPO process. With a direct listing, the way we find the price is democratised,” added Ibrahim.
“When the price opens it is really dictated by supply and demand of the trading floor. It is not the price that is decided by a few bankers the night before with a pool of investors that is very small, which is probably the best way to find the correct price.”
This form of pricing may benefit some companies. For example, shares for the company Roblox (which is NYSE’s most recent direct listing) were priced at $45 in January 2021 after a private financing round. Yet when it opened on the trading floor, its share price increased by 43% to $64.50.
Why would a company choose to do a direct listing?
Companies looking to go public have several options. There are multiple reasons why they would choose to utilise a direct listing rather than a traditional IPO.
“A reason why a company would choose to do a direct listing is that you take away some of the complexity and volatility that might be built in into the traditional IPO structure,” said Kostyal.
A typical company opting for a direct listing would typically not be in a position where they need to raise money. They would already have enough from a cash flow perspective and are simply selling existing shares to gain the benefit of becoming a listed company.
Aside from reducing complexity and volatility, adding speed and certainty is another key reason why a company may choose to do a direct listing.
“For a direct listing, as long as you’re eligible and your document is approved, then you will list – so there’s that certainty. Lack of certainty in IPOs is quite a big issue and a major reason for the SPAC [special purpose acquisition company] boom,” said Harry Keegan, corporate partner at Akin Gump in London.
“Additionally, they don’t need to involve marketing or a sale at the time of the IPO which shortens the process,” he continued.
What are the downsides to a direct listing?
There are of course considerations when opting for this route.
“One major downside is that a company might not be able to bring in substantial anchor investors that take a long-term position in the company,” said Kostyal.
“That’s why you see a lot of these companies that do direct listings actually do a number of secondaries before the listings itself,” he continued. “They do it to build price expectations and they want to transition out early investor and bring in more public market investors willing to be anchor investors.”
For example, Coinbase conducted a series of secondary listings on the Nasdaq private market to create price transparency. It also shifted out some early investors, brought in more crossover investors and supported the company with the direct listing.
Another potential downside is uncertainty with regards to pricing.
“You’ve got to somehow establish what that day one share price will be. In a normal IPO you would have a book building process to help establish that share price,” said Roe. “In a direct listing, you need an alternative way to establish the price. “
“With a conventional IPO the banks will set a price range and, even if you end up pricing at the bottom or a bit below, you still have a good indication people will value the company at a certain level. But with a direct listing you may not know until you’re on the market,” Keegan further explained.
What sorts of companies would look to do a direct listing?
The lack of price certainty, companies who choose to do a direct listing tend to be more well-known amongst the public.
“I can absolutely see why companies such as Spotify or Coinbase, companies with a huge public following already, would do a direct listing,” said Keegan. “They don’t need the help of investment banks to market their shares and the direct listing generates them even more publicity.”
Roe agrees with this notion. “If a company has a more well-known equity story it helps facilitate an active market in the shares absent a book building process that you would have in a more traditional IPO.”