Direct listings are an alternative to Initial Public Offerings (IPOs) in which a company does not work with an investment bank to underwrite the issuing of stock. While forgoing the safety net of an underwriter provides a company with a quicker, less expensive way to raise capital, the opening stock price will be entirely subject to market demand and potential market swings.
In a direct listing, instead of raising new outside capital like an IPO, a company’s employees and investors convert their ownership into a stock that is then listed on a stock exchange. Once the stock is listed, shares can be purchased by the general public, and existing investors can cash out at any time without the ‘lock up’ period of traditional IPOs. Spotify is a recent example of a company that has opted to skip a formal IPO process and instead list its shares directly on an exchange.
In an IPO, newly issued shares are initially priced by agreement among the issuer and the underwriters and sold to public investors by its underwriters. These shares are placed with a group of investors the investment banking syndicate has assembled. Only after this sale is completed can the shares begin trading. The initial trade is executed through an NYSE opening auction.
There are no underwriters in a Direct Listing with a capital raise, and no shares are sold before the NYSE opening auction. The initial pricing is established during the auction in a fully transparent process with the entire marketable to set the price.
All companies planning a Direct Listing must file a prospectus with the SEC with or without a capital raise. This is also required of companies planning IPOs. Further, once a company has completed its Direct Listing, it will have to make all SEC-required ongoing public company disclosures, including annual reports and proxy filings.
At the outset, the best candidates are likely well-known firms with transparent business models that don’t need underwriters to drum up consistent demand for their shares. A traditional IPO provides more security, as it nearly guarantees investors will buy up shares when they become available. It also usually keeps a handful of investors from selling within a short period.