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Financial Literacy

Direct Listing vs. IPO: An Overview to Going Public

Companies often choose between a direct listing vs. IPO to go public. Recent SEC rule changes have increased the popularity of direct listings. Now, companies can raise new capital by listing existing shares directly on the market.

Direct listings are more affordable than traditional IPOs. In a direct process, there are no intermediaries. A company does not work with an investment bank, broker-dealer or underwriter. This means lower fees and fewer regulations.

But what are the benefits? Could direct listings become the new standard for going public? Let’s take a look at the details…

Direct Listing vs. IPO

Going public with a direct listing vs. a traditional offering

What are the reasons for going public? A company’s IPO opens it up to new investors. It helps raise funds this way. But it’s not that easy. The process of going public takes time and can be costly. A company can IPO through a traditional process, a direct listing or a SPAC.

The Role of the Underwriter in a Direct Listing vs. IPO

As part of a traditional IPO, the intermediary acts as a middleman between a company and the investing public. Generally, the intermediary is involved in every aspect of the IPO. This includes the document preparation, filing and issuance of the IPO.

This is one of the biggest differences between a direct listing vs. IPO. A company does not need underwriters when it goes public through a direct listing. Here are the details…

Direct Listing Process

A direct listing allows a private company to sell shares to the public without intermediaries. It is exactly how it sounds: direct.

This process skips the bank-backing steps of a traditional initial public offering. Existing stock owned by employees and investors is listed on the exchange. The public is then able to buy those shares.

Direct listings are ideal for established companies with a loyal client base. This is because people are already familiar with the brand. They don’t need the added exposure that comes with the traditional IPO process.

Small companies opt for direct listings because they’re a quicker, less expensive way to go public. A company may not have the financial resources to afford an underwriter. Some companies also prefer direct listings to avoid diluting existing ownership or a lockup period.

Traditional Initial Public Offering Process

A company issues new stock shares during an initial public offering. Companies going public for the first time face more regulations. Many companies will hire an underwriter to manage the process.

An investment bank usually underwrites an IPO. It serves as an intermediary between the company and investors. It helps determine the initial offer price of a stock and buys shares from the issuing company.

One important piece of the process is the IPO roadshow. This is a sales pitch to build interest before the company goes public. And the IPO roadshow usually takes one to two weeks.

The investment bank helps to tell the company’s story. They try to find what price investors are willing to pay and how many shares they want. The company and underwriter are then able to determine how many shares to sell and at what price.

An underwriter is an added safety net because it signs an agreement to buy and sell shares. And every underwriting agreement is different. An investment bank can decide how much risk it wants to take on.

There Are Three Types of Underwriting Agreements…

  1. Bought Deal – The underwriter agrees to buy the entire IPO issue. The underwriter will have to resell all shares to make money. The underwriter bears all risk of selling the stock.
  2. Best-Effort Deal – This is an agreement from an underwriter to make its “best efforts” to sell the issued shares to the public. The underwriter does not buy any shares.
  3. All-or-None Agreement – This is the least common agreement. The company and underwriter agree to cancel the IPO if not all shares sell.

Direct Listing vs. IPO: Pros and Cons

I’ve gathered some pros and cons for the process of going public for a direct listing vs. IPO. Here are the details…

Direct Listing Pros and Cons

Direct listings allow a company to raise money to go public without the hassle and cost of a traditional IPO. But waiving the safety net of an intermediary can be risky. Going public without an underwriter can put a company at higher share price risk. This is because banks can help build investor interest for an IPO.

Private shares are listed on a public stock exchange without the help of an intermediary. There is no guarantee of selling shares at a certain price.

Supply and demand determine the share price. No transactions will occur if there is no market demand. With a direct listing, a company has to build interest from the investor community on its own.

Companies generally still use traditional IPOs because of the added safety. But more companies are leaning toward direct listings. They’re faster and cheaper. The success of Spotify’s and Slack Technologies’ direct listings have gained media attention. And analysts predict direct listings will become more common for companies going public.

Traditional IPO Pros and Cons

Traditional IPOs have been the standard for going public. They can bring in a lot of new capital and boost a company’s progress. They can also increase exposure to potential customers.

The big downsides to this process, though, are time and cost. The traditional IPO process can take six months to a year. The SEC requires several contracts between the underwriter and the company.

Underwriting is usually the most expensive part of the IPO process. Hiring an underwriter can cost around 5% of the offering. That can easily result in millions or tens of millions of dollars in fees per IPO.

Direct Listing vs. IPO: Final Takeaways

A company that goes public through a direct listing vs. IPO often has different goals. Companies choosing a direct listing approach may not necessarily be seeking capital. With a traditional IPO, a company is often trying to raise capital for funding and expansion.

SPAC IPOs are also gaining momentum, though. To learn more about that process, check out that link.

As always, make sure to research before you invest in a company that’s just recently gone public. IPOs can be volatile for the first few months. And share prices can change quickly. But if IPO investing interests you, check out our top recent IPOs and our IPO calendar. We update it daily to give you the latest news on upcoming and filed IPOs.

If you’re looking for the latest investment opportunities, consider signing up for Liberty Through Wealth. This free e-letter is full of market insights from leading experts. You’ll hear directly from bestselling author and investment expert Alexander Green. He’s also worked as an investment advisor, research analyst and portfolio manager on Wall Street for 16 years.


About

Aimee Bohn graduated from the College of Business and Economics at Towson University. Her background in marketing research helps her uncover valuable trends. Researching IPOs and other trends has been her primary focus over the past year. When Aimee isn’t writing for Investment U, you can usually find her doing graphic design or traveling with friends.

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