The Rise Of Direct Listings: Understanding The Trend, Separating Fact From Fiction

Author:Mr Ran Ben-Tzur and James D. Evans
Profession:Fenwick & West LLP
 
FREE EXCERPT

Direct Listings: The What, The Why and Common Misconceptions

Spotify did it. Slack did it. Many other late-stage private technology companies are reported to be seriously considering doing it. Should yours? In this article, we discuss why direct listings are all the rage and common misconceptions.

IPO vs. Direct Listing: What's Right for Your Company?

The high-profile public market debuts of tech unicorns Spotify and Slack are encouraging many late-stage, venture-backed companies to consider whether a direct listing makes sense for them. In this article, we explore the pros and cons of direct listings relative to a traditional IPO and some key considerations before choosing the direct listing structure.

How to Prepare for a Direct Listing—Best Practices

Assuming you've already weighed the pros and cons and decided that a direct listing is right for your company, we've put together a list of a few must-do items to ensure everything goes as planned prior to listing your stock directly.

Direct Listings: The What, The Why and Common Misconceptions

Spotify did it. Slack did it. Many other late-stage private technology companies are reported to be seriously considering doing it. Should yours?

If you are a board member of a late-stage, venture-backed company or part of its management team, you likely have heard the term "direct listing" in the news. Or you may have attended one or all of the slew of recent conferences being hosted by big-name investment banks and others, including tech investor guru Bill Gurley, who recently debated the pros and cons of choosing a direct listing over a traditional IPO.

Before you decide what's right for your company, here are a few things you need to know about direct listings.

Just What Is a Direct Listing?

For people not familiar with the term, a direct listing is an alternative way for a private company to "go public," but without selling its shares directly to the public and without the traditional underwriting assistance of investment bankers.

In a traditional IPO, a company raises money and creates a public market for its shares by selling newly created stock to investors. In some instances, a select number of investors may also sell a portion of their holdings in the IPO, although in most instances this opportunity is reserved for very large stockholders or employees and is not made broadly available to other pre-IPO stockholders. In an IPO, the company engages investment bankers to help promote, price and sell the stock to investors. The investment bankers are paid a commission for their work that is based on the size of the IPO—usually 7 percent in the case of a traditional technology company IPO. In a direct listing, a company does not sell stock directly to investors and does not receive any new capital. Instead, it facilitates the re-sale of shares held by company insiders such as employees, executives and pre-IPO investors. Investors in a direct listing buy shares directly from these company insiders.

So now you ask: If my company does a direct listing, does this mean that we don't need investment banks? Not quite. Companies still engage investment banks to assist with a direct listing, and those banks still get paid quite well (to the tune of $35 million in Spotify and $22 million in Slack). However, the investment banks play a very different role in a direct listing. Unlike in a traditional IPO, in a direct listing, investment banks are prohibited under current law from organizing or attending investor meetings, and they do not sell stock to investors. Instead, they act purely in an advisory capacity, helping a company to position its story to investors, draft its IPO disclosures, educate the company's insiders on the process and strategize on investor outreach and liquidity.

Why Have Companies Only Started Considering Direct Listings Recently?

The concept of a direct listing is actually not a new one. Companies in a variety of industries have used similar structures for years. However, the structure has only recently received a lot of investor and media attention because high-profile technology companies have started to use it to go public. But why have technology companies only recently started to consider direct listings? A few trends have emerged in recent years that have made direct listings a viable, and sometimes attractive, option relative to an IPO:

The Rise of Massive Pre-IPO Fundraising Rounds: With an abundance of investor capital, especially from institutional investors that historically hadn't invested in private technology companies, massive pre-IPO fundraising rounds have become the norm. Slack raised over $400 million in August 2018—just over a year prior to its direct listing. Because of this widespread availability of capital, some technology companies are now able to raise sufficient capital before their actual IPO either to become profitable or to put them on a path to profitability.

The Insider Sentiment Against the Current IPO Process: There has been increasing negative sentiment, especially amongst well-known venture capitalists, about certain aspects of the traditional IPO process—namely IPO lock-up agreements and the pricing and allocation process.

IPO Lock-Up Agreements. In a traditional IPO, investment bankers require pre-IPO investors, employees and the company to sign an agreement restricting them from selling or distributing shares for a specified period of time following the IPOusually 180 days. This agreement is referred to as a "lock-up agreement." The bankers argue that these agreements are necessary in order to stabilize the stock immediately after the IPO. While the merits of a lock-up agreement can certainly be debated, by the time VCs (and other insiders) are allowed to...

To continue reading

FREE SIGN UP