Lex Midweek Letter: direct listings vs IPOs

Dear readers,

This has been the biggest year yet for direct listings — a hot topic in tech markets.

So far in 2021, cryptocurrency exchange Coinbase, video game platform Roblox, US job listing site ZipRecruiter, website creator Squarespace and UK fintech Wise have all sold shares directly to the public. The mini-rush follows Palantir and Asana both opting for a direct listing on the same day last autumn. App-maker TrillerNet may join their ranks.

Direct listings are supposed to be Silicon Valley’s way of disrupting initial public offerings — a shortcut to markets that avoids big investment bank fees and first-day price pops.

Less than three years after Spotify made headlines as the first notable company to go public this way, direct listings got a big boost when the Securities and Exchange Commission approved the New York Stock Exchange’s plan to allow companies to both sell shares directly to the public and still raise capital — something that had not been previously allowed.

Venture capitalist Bill Gurley declared this change would “unquestionably” lead to the end of IPOs. Yet no company has taken this hybrid option, perhaps wary of being the first. Meanwhile, there have been 587 IPOs in the US this year.

For existing investors in a company, the advantages of a direct listing are twofold: stock immediately freely trades and the market sets the price. In theory, this should mean less money left on the table by nervous intermediaries.

Coinbase joined the stock market via a direct listing this year with a $76bn valuation. That was up 850 per cent on its last private valuation in late 2018. Since then, however, Coinbase’s price has dropped along with the price of bitcoin. It has even fallen below its $250 per share reference price. 

Reference or guide prices are not the same as IPO offering prices set by investment banks and intended to fairly reflect the value of a company. Reference prices simply provide a starting point. This may not have been communicated to public investors. When Squarespace listed in May it also dropped below its guide price. 

For new investors, there are multiple drawbacks. Most companies that go through an IPO sell a set percentage of their shares and prevent early investors from selling stock for a few months. In a direct listing, the number of shares available to trade is hard to estimate, given they do not carry the same restrictions. 

There is also a lack of information. Direct listings remove roadshows from the equation and may leave potential investors with less financial data to assess.

For companies, direct listings are also not quite as free from constraints as their name suggests. Investment banks may not act as underwriters but they are often hired to give advice. Intermediaries have a way of reinserting themselves.

Direct listings are good for companies that want to let early investors cash out quickly. But when direct listing share prices fall below the guide price, start-ups considering their options are likely to turn back to traditional IPOs. The status quo will remain intact.

Enjoy the rest of your week.

Elaine Moore
Deputy head of Lex