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Traditional IPO vs. Modern Direct Listing

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The good old-fashioned IPO is no longer the only way for ambitious companies to test public waters.

The SPACs we discussed in a previous post, are not new. But they had a bad reputation in the past, for bringing fraudulent businesses🤡 to the public, so most companies used to avoid this listing path. But 2020 is another story — SPACs are everywhere.

The latest threat to IPOs is called direct listing. It’s a cool, modern, and inexpensive way for companies to get listed on the stock market — at this time, this method is only available on the NYSE. But before getting into the details of what makes direct listings so interesting, make sure you know how to find the best tech stocks — regardless of how they went public.

What’s their Difference?

An initial public offering (IPO) is a method for companies to raise fresh capital by listing shares on a public exchange. The listing company creates new shares and hires an underwriter (an investment bank) to help them sell the shares. But, this is an expensive process.🏷️

On the other hand, in the direct listing method, no new shares are created — meaning no capital is raised — and only existing, outstanding shares are sold with no underwriters involved. However, a direct listing is not the best option for most companies, as we’ll see.

Why Companies Choose the Direct Listing Method?

1.They don’t have to wait for a lockup period to expire:

Lockup period is the amount of time after an IPO where large shareholders such as executives and early investors cannot sell their shares. It typically lasts 90-180 days.

In the direct listing process, there’s no lockup period meaning that insiders can sell their shares freely from the very first day.

2.They don’t need capital immediately:

It’s no coincidence that heavily-funded tech startups choose the direct listing path. They usually don’t need capital immediately, so why issue new shares and dilute current shareholders? Also, these companies are usually highly recognizable brands. This is very important since there are no underwriters to promote their stock.

3.They hate underwriting fees:

Direct listings are much cheaper than traditional IPOs. In an IPO underwriters play a big role in marketing the company. They do the leg work of bringing in prospective suitors, including hosting “roadshows” that explain to investors why they should buy shares in the company. But for their work they charge 2%-8% of the total capital raised.

Haran Segram, an assistant professor of finance at the NYU Stern, estimates that Spotify saved $100 million through its direct listing!😲

Photo by Gilly on Unsplash

An IPO Is Still the Best Choice for Most Companies

 A direct listing is pretty much a DIY process.

Since there are no underwriters to streamline the process, there’s no support or guarantee for the share sale, no promotions, and no safe long-term investors. That’s why only high-profile companies like Spotify, Asana, or Slack have chosen this method so far.

The vast majority of companies that are not so well-known will not be able to sell their shares without the help of underwriters. In this case, an IPO (or even a SPAC merger💡) is still the best option.👌

Thanks for reading🙏


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