Source: Unsplash
TLDR
- Startup founders can use direct listings on publicly-traded exchanges or special purpose acquisition companies (SPACs) when deciding to go public. Some startups choose a direct listing, where no new shares are created. Only existing, outstanding shares are sold. Other startup founders may choose a SPAC as the path to “going public.”
- 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.
- 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.”
- SPACs have no other operational purpose than to raise capital through an IPO for the sole purpose of acquiring or merging with the company choosing to go public. SPACs “raise money largely from public-equity investors and have the potential to [de-risk] and shorten the IPO process for their target companies, often offering them better terms than a traditional IPO would.”
- 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.
- 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.
- The primary reason startups choose a SPAC over an IPO when going public is the faster time, the ability to raise additional capital through the SPAC after the IPO, lower marketing costs, and access to operational expertise.
If you have a fast-growing startup, you may consider going public at some point in the future. However, often, “going public” isn’t an easy (or affordable) process. It involves days and days of due diligence while also preparing your startup to run as a publicly-traded company.
And, of course, there’s capital and investors. No small feat, to be sure.
Startup founders can use direct listings on publicly-traded exchanges or special purpose acquisition companies (SPACs) when deciding to go public.
Some startups choose a direct listing, where no new shares are created. Only existing, outstanding shares are sold. Other startup founders may choose a SPAC as the path to “going public.”
This article will break down the differences between direct listings and SPACs, 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 a 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.”
SPACs have no other operational purpose than to raise capital through an IPO for the sole purpose of acquiring or merging with the company choosing to go public. SPACs “raise money largely from public-equity investors and have the potential to [de-risk] and shorten the IPO process for their target companies, often offering them better terms than a traditional IPO would.”
According to Corporate Finance Institute, “when the SPAC raises the required funds through an IPO, the money is held in a trust until a predetermined period elapses or the desired acquisition is made. If the planned acquisition is not made or legal formalities are still pending, the SPAC must return the funds to the investors, after deducting bank and broker fees.”
Let’s look at how this occurs in image form.
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.”
Harvard Business Review notes that “we believe that SPACs are here to stay and maybe a net positive for the capital markets. Why? Because they offer investors and targets a new set of financing opportunities that compete with later-stage venture capital, private equity, direct listings, and the traditional IPO process. They provide an infusion of capital to a broader universe of startups and other companies, fueling innovation and growth.” In other words, “SPACs have allowed many companies to raise more funds than alternative options do, propelling innovation in a range of industries.”
Direct Listing vs. SPAC vs. IPO
To add to the choices of how to go public, startup founders can also utilize an initial public offering (IPO).
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.
More of a summary view, notice how to direct listings, SPACs, and IPOs stack up against one another in 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 a SPAC?
Let’s now look at some pros and cons of SPACs.
First, the pros. The primary reason startups choose a SPAC over an IPO when going public is the faster time, the ability to raise additional capital through the SPAC after the IPO, lower marketing costs, and access to operational expertise.
However, there are also risks associated with SPAC mergers or acquisitions. For example, SPAC sponsors “usually own a 20 percent stake in the SPAC through founder shares or ‘promote,’ and warrants to purchase more shares. SPAC sponsors also benefit from an earnout component, allowing them to receive more shares when the stock price achieves a specified target over a certain time frame, leading to further dilution.”
Additionally, although the SPACs are more time-efficient, it creates a “[c]ompressed timeline for public company readiness,” such as creating internal controls and establishing a qualified board of directors and leadership team. Also, because the SPACs don’t “require the rigorous due diligence of a traditional IPO, [the lack of these processes could] lead to potential restatements, incorrectly valued businesses or even lawsuits.”
Finally, SPACs don’t require underwriting, meaning that an underwriter guarantees the stock prices. According to KPMG, “[i]n a traditional IPO, the underwriter makes sure all regulatory requirements are met, but the target company doesn’t have an underwriter because a SPAC is already public.”
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If you want to learn more about direct listings and SPACs, 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!
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