Among this year’s highly anticipated lineup of unicorn public offerings, one stood out from the rest. Following Spotify’s 2018 direct public offering (DPO) success, Slack became the second notable technology giant that opted for an alternative path to the public market, bypassing a traditional IPO.
A DPO, better known as a direct listing, allows a company to list its shares on an exchange without a firm underwriting from an investment bank. Traditionally, companies seek an IPO to raise capital, and investment banks serve as a stabilizing agent during the IPO process. Investment banks advise companies on an offering price, purchase shares directly from the issuer, then promote and distribute the allotment to their network of institutional investors. In return for this orderly process, bankers earn a cut from the proceeds raised.
In a direct listing, the company’s existing shareholders—comprised of founders, employees and investors—can sell their shares in the open market at a price determined by market demand and supply. Investment banks can still earn an advisory fee in a direct listing, albeit at a reduced rate. Removing underwriting support is a daring move since public appetite (and pricing) can be unpredictable. There will be no stabilizing bids from investment banks to help manage volatility if the offering does not proceed positively. However, in successful cases such as Slack and Spotify, the primary benefits include reduced transaction costs, improved access to liquidity (i.e. no lockup period restrictions) and increased transparency in price discovery.
A direct listing is not a novel concept. In 1984, Ben & Jerry’s raised $750,000 by selling shares directly to “Vermonters.” The six-year-old eccentric ice cream flavor startup needed funding to expand its 600,000-gallon-per-year facility. Through Regulation A, the founding pair advertised under the tag line “Get a Scoop of the Action” in local newspapers and on their ice cream pints. Listing directly allowed Ben & Jerry’s to meet its financing goals while providing a way for Vermont residents to benefit from the company’s growth.
A do-it-yourself IPO sure sounds like the type of challenge that would appeal to tech entrepreneurs and new-age CFOs, but what other factors contributed to Silicon Valley’s interest in old-time flavors such as direct listing?
Having a well-known brand and some cash on the balance sheet both factor into the success of a direct listing. Spotify and Slack have recognizable brands, and neither need an immediate cash infusion.
At the time of their listings, Spotify and Slack had a cash and marketable securities balance of €1.5 billion, and $793 million, respectively. High cash balance could indicate a company’s strong cash flow position (Spotify has been cash-flow positive since 2016) and/or a trend of mega- deals as more institutional investors cross over to the private market space.
If the company’s goal isn’t to raise capital, why go public? Because companies are debuting
on the public markets later in the lifecycle than they were two decades ago, they need to find ways to provide liquidity to early investors and employees. Being a public company also brings a higher level of prominence and transparency to the market, which can assist in sales, partnerships and recruitment.
Unlike a tender offer—which provides a restricted opportunity for certain employees and investors to cash out a portion of their holdings—a direct listing provides liquidity to long-term shareholders at the prevailing market price and an avenue for the company to raise new capital in the future.
A direct listing also takes some guesswork out of the pricing process for IPO shares, making it a desirable choice when the goal is to offer liquidity to shareholders. Since no new shares are created during a direct listing, high market demand by investors can produce attractive returns for the selling shareholders.
Are Spotify and Slack trendsetters or one-off mavericks? Direct listings are not necessarily suitable for companies that need to raise cash
to fuel growth, those with business models too complicated for retail investors to understand or those with lesser-known brands.
However, the resurgent interest in direct listing by tech unicorns will generate conversations
for issuers and investment banks to reevaluate certain aspects of the conventional IPO process (i.e. lockup period duration, pricing discovery methods, etc.). This could be yet another indirect way for Silicon Valley to push the financial services world forward.