What is a direct listing?
A direct listing is a process in which a company can go public by selling existing shares instead of offering new ones. Companies that choose to go public using this process usually have different goals than those that use an initial public offering (IPO).
Quick Summary Points
- Direct listing is a process for a company to become public without going through the initial public offering process
- This process brings the existing stock owned by employees and investors available for the public and does not require underwriters or a lock-up period
- Direct listing increases liquidity for existing shareholders and is usually cheaper than IPOs
Direct listing vs. Initial Public Offerings (IPO)
The major difference between a direct listing and an IPO is that one sells existing stocks while the other issue new ones. In a direct listing, employees and investors sell their existing stocks to the public. In an IPO, a company sell part of the company by issuing new stocks. This is because the goal of companies that become public through this method is not additional capital, which is why new shares are not necessary.
The second difference is that in a direct listing there are no underwriters. Underwriters work for investment banks to help sell stocks of a company that is going public. They make large purchases which adds value to companies as those shares are taken off their hands. However, the shares are sold at a discount, which means at a lower price than it is worth. The process of using underwriters and selling at a discount increases the time and cost for a company that is issuing shares. The practice of investment banks buying stocks and then selling is not as common now. Instead, the investment banks will use their network to help market the stocks and drive sales. Either way, by avoiding IPOs, companies can avoid the extra fees paid to banks.
Lastly, the direct listing process also does not have the “lock-up” period. In traditional IPOs, though not required, companies have lock-up periods in which existing shareholders are not allowed to sell shares in the public market. This prevents large supply in the market which will decrease the price of the stock. In direct listings, existing shareholders can sell their shares right when the public goes public. This is due to the nature of the direct listings. Since no new shares are issued, transactions will only occur if existing shareholders sell their shares.
Benefits and drawbacks of a direct listing
There are several benefits of a direct listing that attract companies to the process. Firstly, by going public, the company provides liquidity for shareholders. This increases liquidity by allowing shareholders to freely sell their shares in the public market. Secondly, the cost of the process is much lower than an IPO. Direct listing help companies avoid hefty fees paid to investment banks. It also helps them avoid the indirect cost of selling the stocks of selling at a discount.
Since direct listing does not use investment banks to underwrite the stocks, there is some more volatility. Firstly, the availability of stocks depends on current employees and investors. If on the day of, no employees or investors want to sell their share, then no transaction will occur. Secondly, the price is purely dependent on market demand. Unlike an IPO in which share price is negotiated beforehand, in a direct listing the price of the stocks will depend on public demand. This increases volatility as the range in which the stock is traded is less predictable.
Why do companies choose direct listing?
Companies that use direct listing have different goals than those that choose an IPO. In an IPO, companies are trying to raise capital for expansion or funding. On the other hand, companies that use direct are not necessarily seeking capital. Instead, they are looking for the other benefits of being a public company such as increasing liquidity.
Companies that want to go public through this process should also fit a certain profile. Since no underwriters are selling the stocks, the company itself has to be attractive enough for the market. The rough outline of companies that should use this method includes those that are: (1) consumer-facing with strong brand equity; (2) easy to understand business models; (3) not in need for capital.
Two notable companies that have has gone public through direct listings are Spotify and Slack. Both of these companies already have strong reputations before going public. They were commonly used and it was easy to understand how the company makes money. These two things combined increase the number of people who are interested in investing in the company. This is because investors are more inclined to invest in companies that they have heard of before and understand.
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