Source: Unsplash
TLDR
- Two methods for raising capital and “going public” are to directly list shares on a public exchange (such as the New York Stock Exchange or NASDAQ) or by participating in an initial public offering (IPO).
- When companies decide to “go public” through a direct listing, they sell currently issued and outstanding shares. They do not create new shares for sale, as in an IPO. Instead, through a direct listing, the startup sells these available shares directly to the public, without the help of (or the need for) any intermediaries, such as underwriters.
- Additionally, the existing investors, founders, and employees that hold startup stock can sell their shares to the public. However, as noted above, without having an underwriter, the share prices aren’t supported or guaranteed, which can cause issues after the shares are listed.
- An initial public offering (IPO) is a limited sale of new shares in a startup that has decided to “go public.” The general public and institutional investors can buy IPO shares. An institutional investor is an entity that invests on behalf of its members, such as a pension fund.
- Once the IPO concludes, the startup is officially a public company and begins trading on a national stock exchange. Additionally, the IPO must comply with all notices and filings required for public-traded companies like direct listings.
- The significant difference between a direct listing and an IPO is the shares offered. For direct listings, no new shares are issued. Instead, investors buy existing, outstanding shares. For IPOs, new shares are issued for the purchase.
- Another difference is that IPOs require underwriters (and their expense). Direct listings, on the other hand, do not use underwriters. However, as we’ve noted, direct listings do not have a guarantee on the stock prices and value.
- A final difference is that direct listings don’t require a “lock-up” period for the stock, whereas IPOs do. A lock-up represents a period where shareholders cannot sell their shares to the public. This prevents IPOs from creating an ample supply of stock in the market, essentially decreasing the stock price.
As a startup, raising capital is a top priority. So is deciding how to “go public” when the time is right. Two methods for doing both are directly listing shares on a public exchange (such as the New York Stock Exchange or NASDAQ) or participating in an initial public offering (IPO).
Some startups choose an IPO, where new shares are created and underwritten. Then, the shares are sold to the public. Other startups choose a direct listing, where no new shares are created. Only existing, outstanding shares are sold. Direct listings don’t involve underwriters.
Because of the lack of underwriting, direct listings are less expensive than IPOs. However, founders operate without the assurances that their shares will sell without underwriting.
This article will break down the differences between direct listings and IPOs, including the pros and cons.
What Is a Direct Listing?
Let’s now look at direct listings in more detail.
When companies decide to “go public” through a direct listing, they sell currently issued and outstanding shares. They do not create new shares for sale, as in an IPO.
Instead, through a direct listing, the startup sells these available shares directly to the public, without the help of (or the need for) any intermediaries, such as underwriters. Additionally, the existing investors, founders, and employees that hold startup stock can sell their shares to the public. However, as noted above, without having an underwriter, the share prices aren’t supported or guaranteed, which can cause issues after the shares are listed.
The startup does have to file a public registration statement with the Securities and Exchange Commission (SEC) at least 15 days before listing the shares. After filing the SEC registration statement, the startup must comply with all reporting and governance requirements for publicly-traded companies, such as 10-Ks.
Note that direct listings are also referred to as a direct listing process (DLP), direct placement, or direct public offering (DPO).
In late 2019, the NYSE created a new SEC filing, allowing startups to raise capital and go public through the direct listing process. Under this NYSE process, the startup must sell at least $250 million worth of stock. However, the SEC rejected the NYSE’s proposal.
In December 2020, the SEC announced that private companies could raise capital through direct listings, allowing them to go public without an IPO. Two early successes in this process were Spotify and Slack.
What Is an IPO?
Now, let’s move on to IPOs.
An initial public offering (IPO) is a limited sale of new shares in a startup that has decided to “go public.” The general public and institutional investors can buy IPO shares. An institutional investor is an entity that invests on behalf of its members, such as a pension fund.
Once the IPO concludes, the startup is officially a public company and begins trading on a national stock exchange. Additionally, the IPO must comply with all notices and filings required for public-traded companies like direct listings.
To complete a successful IPO, startups need to complete the following process:
- Due Diligence: As a startup moves from a private company to a public company, it should conduct due diligence, where it discloses financial, management, and business documents. These documents are presented to investment banks for further review.
- Underwriting: As we’ve noted, startups wishing to undergo an IPO must participate in underwriting. An underwriter is a financial professional that guarantees the startup’s value to investors. Underwriters may work for investment banks, or they may be certified public accountants (CPAs), lawyers, or other financial professionals well-versed in SEC requirements and IPOs. Remember that underwriters often charge three to seven percent per share for their services.
- FIling IPO Documents: Next, the startup must file all of the appropriate applications and documents required by the SEC. For example, startups must file an S-1 Registration Statement, which includes a prospectus of the startup for disclosure to regulators.
- Marketing Your IPO: Startups don’t want to keep this process quiet. Instead, they should market and advertise the IPO to the public, getting investors excited about the startup going public. The founders will need to convey their valuation during this process, hoping that the IPO will live up to those numbers.
- Set the Date of the IPO: Once you have all documents filed with the SEC and you’ve completed the underwriting process, you set your IPO date. However, once you place your IPO date, you may have to delay the IPO date for various reasons, such as valuation issues or lack of interest.
Direct Listing vs. IPO
As we’ve seen above, the significant difference between a direct listing and an IPO is the shares offered. For direct listings, no new shares are issued. Instead, investors buy existing, outstanding shares. For IPOs, new shares are issued for the purchase.
Secondly, IPOs require underwriters (and the expense associated with them). Direct listings, on the other hand, do not use underwriters. However, as we’ve noted, direct listings do not have a guarantee on the stock prices and value.
Third, direct listings don’t require a “lock-up” period for the stock, whereas IPOs do. A lock-up represents a period where shareholders cannot sell their shares to the public. This prevents IPOs from creating an ample supply of stock in the market, essentially decreasing the stock price.
See the chart below summarizing the difference between direct listings and IPOs.
Direct Listing vs. IPO vs. SPAC
Another way to raise money to go public is through a special purpose acquisition company (SPAC). A SPAC is “a corporation formed to raise investment capital through an initial public offering (IPO).”
So how do SPACs work? According to Corporate Finance Institute, “such a business structure allows investors to contribute money towards a fund, which is then used to acquire one or more unspecified businesses to be identified after the IPO.” Often, SPACs are called “blank-check companies.”
SPACs have no other operational purpose other than raising capital through an IPO to acquire or merge with an existing company -- for example, the startup wishing to go public.
Although SPACs have been around for decades, they’ve recently become more popular. According to Harvard Business Review, “[a]lthough SPACs, which offer an alternative to traditional IPOs, have been in various forms for decades. They’ve taken off in the United States over the past two years. In 2019, 59 were created, with $13 billion invested; in 2020, 247 were created, with $80 billion invested; and in the first quarter alone of 2021, 295 were created, with $96 billion invested. Then there’s this remarkable fact: In 2020, SPACs accounted for more than 50% of new publicly listed U.S. companies.”
For a glance at how SPACs differ from direct listings or IPOs (along with examples of each), please review the chart below.
What Are the Pros and Cons of a Direct Listing?
Let’s now look at some pros and cons of a direct listing.
For the pros, direct listings are typically less expensive than IPOs and SPACs. Founders don’t have to pay an underwriter to guarantee the value of the shares or investment banks for the IPO filing process.
Additionally, a direct listing provides some liquidity for the founders by selling existing shares.
On the other hand, since direct listings don’t use an underwriter, the availability of the stock and the price of the stock can create more volatility. For example, since no new shares are made, no stock sale will occur if employees decide not to sell their shares of stock. Founders have to rely solely on market demand.
What Are the Pros and Cons of an IPO?
Let’s now look at some pros and cons of IPOs.
For the pros, founders get access to large cash injections with an IPO, creating a favorable financial position moving forward. Additionally, by issuing new shares, the startup protects future trading of the shares instead of buying and selling existing equity.
Marketing your IPO and having a successful launch can create quite the buzz for your company, creating additional publicity for your startup.
On the other hand, IPOs are pricey. Hiring a stellar board and top talent to attract investors in your IPO adds to your costs in addition to underwriters and investment banks. Further, there’s significant pressure to deliver success when embarking upon an IPO.
We can help!
At AbstractOps, we help early-stage founders streamline and automate regulatory and legal ops, HR, and finance so you can focus on what matters most—your business.
If you want to learn more about direct listings and IPOs, we can help you draft the appropriate documents for your startup. Additionally, we can get your documentation ready, shepherding this process to ensure it’s done right. Get in touch to learn more!
Like our content?
Subscribe to our blog to stay updated on new posts. Our blog covers advice, inspiration, and practical guides for early-stage founders to navigate their startup journeys.
Note: Our content is for general information purposes only. AbstractOps does not provide legal, accounting, or certified expert advice. Consult a lawyer, CPA, or other professional for such services.