How Will Direct Listings Impact the IPO Market in This New Decade?
Taking companies public on traditional exchanges has never been easy, has always been risky, and can lead to “unintended consequences” for entrepreneurs, their teams, and their original, current, and future investors.
I’ve taken business public, have run public companies, and have built, bought, consolidated and sold businesses, most often in private transactions and have generated $3.75 billion of cumulative gain for investors and management teams, and have learned a lot in the process about the unique nature of every transaction.
Regardless of how these activities have been funded, and how returns have been generated, one thing I can say with certainty is that there is no replacement for the combination of a clear vision for the opportunity to disrupt industries (solving really big problems) and a hard-working, talented team who understand how to plan and execute consistently.
I’ve become increasingly interested in Direct Listings, particularly for technology companies, and not just consumer packaged goods and services companies who have combined Direct Listings with marketing to their most loyal fans as loyal fans love the idea of owning shares in companies they already have supported as consumers.
Tech companies have traditionally looked to IPOs as the best liquidity choice, with underwriters and bankers creating and rolling out new shares sold to the public through listings on Nasdaq, the NYSE, and other venues around the world. Doing so demands an enormous effort, to ensure compliance with regulatory requirements, setting pricing, producing roadshows, selling to institutional as well as smaller investors, and setting up investor relations functions and services – all this is understandably expensive, time-consuming, and a lot more complex than the process may appear to be at the outset. There are also ongoing costs associated with being public that can run into the millions.
Direct Listing is emerging as an increasingly popular alternative to the IPO, and while it does not come with the marketing and operational mechanisms of a traditional IPO, there are benefits.
In a Direct Listing, only existing, outstanding shares are sold, which many company leaders prefer as there is no dilution of existing shares (which happens when new shares are created as part of an IPO). Existing investors and even employees who hold shares can directly sell their shares to the public, with far less bureaucracy and fewer “lockup period” restrictions creating immediate liquidity for founders and early employees who own stock.
Direct Listings are being offered by more and more banks, including Morgan Stanley, a firm which points to the health of private markets, which are becoming more accessible given new technologies which enable trading to occur with transparency, efficiency and fairness.
Direct Listings take less time, and for large-cap companies can access to capital with less related volatility, and as institutional investors become more comfortable with quality Direct Listings, access to very large pools of money are making “going the direct route” an even more interesting option compared to IPOs.
Spotify is probably the most well-known example of a successful Direct Listing, selling 17% of their outstanding shares on the first day of their offering (compared to 10-15% on average sold on the first day of IPOs).
Slack sold 22% of their outstanding shares.
It’s no surprise that tech companies are moving in this direction, given that they understand how technology and networking works, and are sensitive to the amount bankers make on the first day of trading when, for example, they make massive profits on the shares they purchased at the strike price, followed by a nice “pop” when trading starts.
While it makes sense for investors, entrepreneurs, and investment banks to consider a Direct Listing as one alternative pathway to liquidity, there are still many advantages to IPOs. Also last year, online videoconferencing service provider Zoom more than quadrupled their cash and marketable securities position to over $730 million, and cloud security software vendor CrowdStrike soared to an $825 million position. Did these two IPOs make a lot of banks richer? For sure.
But according to Zoom’s CFO Kelly Steckelberg, Zoom “got the most added attention in the financial community,” turning bankers into customers and driving enterprise client growth up 78% compared to the previous year, dramatically improving their MRR profile.
CrowdStrike’s CEO George Kurtz said in an interview that his company’s IPO allowed it “to showcase what we do and how we do it on a much broader stage, particularly internationally.”
Direct listings have been around longer than most people think. The technology is there, the support from public exchanges is there, and the value of standard market-matching pricing is there.
Some experts suggest companies are paying up to 40% for the capital they raise when they go the IPO route, given fees, discounted shares, and underpricing, but they are determining the “marketing” is worth it, especially when they need large new chunks of cash for growth.
With Direct Listings today, there’s currently no way to raise cash because the company doesn’t issue new shares, but even this is being innovated, for example with a “pre-listing round term sheet” that Latham & Watkins, one of the top law firms supporting IPOs, has been developing.
We’re still early in the Direct Listings approach today, and as with any major decision regarding growth capital for companies (be that equity or debt financing, public or private) options should be studied and tested, including the importance of driving market awareness to support the perception of valuation, even as company leaders must also focus on driving organic sales growth as well as acquisitions to create more market power.
Direct Listings are not the only source of innovation when it comes to upending traditional capital markets approaches. Through a Reg “D” offering, for example, companies can raise equity through the sale of their securities without the need to register those securities with the SEC. Often companies doing these offerings will offer something in addition to securities such as incentives like discounts on their products and/or services, members’ clubs, and more.
We can expect to see a steady increase in token offerings, with improvements based on a lot of hard learning from the early days of non-fiat currency trading. Special purpose acquisition companies (SPACs) may also become more common. Tapping public money using new models and technologies, including the use of blockchain to further democratize investing, will become more competitive, which is good for all when we continue to ensure the efficiency, transparency, and access that build trust.
Without trust, no public markets can survive.