Pros & Cons of a Direct Listing vs. an IPO

In late June 2019, the cloud-based collaboration tool Slack (WORK) debuted on the NYSE as a publicly traded company. However, the company didn’t take a traditional IPO route where companies find an underwriter who will help raise funds for the IPO shares, find investors and then ultimately list on the public markets. Slack went with a direct listing, which means no new shares were sold to raise additional capital. Spotify did this last year and had success, as a well-known company there is more interest from investors. There are three main benefits and some potential pitfalls companies will see when doing a direct listing, such as Slack or Spotify.

Pro: No fees
In a traditional IPO, the company going public has to pay a fee, typically 6 or 7 percent of the amount of capital raised by the underwriters. Whereas, If the company is not raising additional capital, they do not have to pay this fee. The company will still pay a lesser fee, typically 1 or 2 percent, to investment banks acting as advisors for the transaction.

Pro: No lockup period
When a company goes public via a traditional IPO the underwriters require a six-month lockup period for certain insiders and major shareholders, meaning they have to wait until after the shares trade for six months in the public domain before they can sell their shares. This can be a detriment to insiders. As an example, if a stock is priced at $20 and initially goes up to $25, but then drops to $15 or $12, six months later, they lose out on the opportunity to sell at a higher price. Thus, one benefit of a direct listing is that existing shareholders do not have to wait to sell their shares.

Pro: Provides equal access
A direct listing also provides a more fair market to participate in at the outset, because anyone — from the general public to institutions — can buy the stock at the same price, whenever it opens for trading. With an IPO, the underwriters select who gets allocations of shares, meaning they decide who can get in on the initial offering price. These investors tend to benefit from getting in on the ground floor of a company going public, often at a lower price than when it starts trading. This problem is part of what we’re trying to solve at ClickIPO, by creating access to IPOs for all investors. Companies that go public can leverage our platform to provide access to the general investing population, democratizing their IPO and by placing shares in the hands of consumers that use their product, whom are generally longer-term shareholders.

Con: No new capital
Typically, going public offers a great opportunity to raise money for the business, so companies miss out on that chance when they do a direct listing. Should they need capital in the future, they missed this initial opportunity. However, companies that go direct usually don’t need any additional capital — for Slack, this was a non-issue.

Con: Can be more volatile
The other potentially negative aspect of a direct listing is that initial trading can be more volatile because institutional buyers have not gone through a price discovery process to set the initial IPO price. With a traditional IPO, there’s a book-building process where major investors and institutions set the value of a company at a certain price, creating a benchmark for what that company is worth before it trades.

Risk of Investing in Initial Public Offerings (“IPOs”)
There are specific risks in investing in an Initial Public Offering (“IPO”). Among other things, the stock has not been subject to market valuation. Those risks are described at length in the prospectus, and we urge you to read the prospectus carefully to understand those risks before investing. An IPO is the first sale of stock by a private company to the public and may not be suitable for all investors. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded. IPOs are a risky investment. For even experienced investors, it can be difficult to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, which are subject to additional uncertainty regarding their future values. Read more information regarding the significant risks associated with investing in IPOs.