What is a Direct Listing and How Does it Impact Your Equity Plan?

Direct listings (also referred to as “direct public offerings”) have gained notoriety over the last few years thanks to the handful of prominent companies that have used them to go public (Coinbase, Spotify, and Slack to name a few).

For a private company planning to enter the public markets, a direct listing may be an appealing alternative to the traditional IPO or Special Purpose Acquisition Company (SPAC). In this article, we’ll discuss how direct listings work, how they differ from an IPO and other key factors to consider.

What is a Direct Listing?

A direct listing is a liquidity event in which a company goes public (i.e. lists its shares on a public stock exchange like Nasdaq or the NYSE) but instead of issuing new shares to investors, it sells existing shares. Essentially, a direct listing lets a company provide liquidity to its shareholders and join the public markets without having to go through the lengthy capital raising and underwriting process.

Direct listings are generally geared towards well-capitalized companies that do not need to raise additional cash or do not necessarily need the heightened brand awareness of an IPO event. At the same time, direct listings are designed to be more flexible than IPOs, which generally require considerable resources and can take multiple years to complete.

It is worth noting that recently the SEC recently began allowing companies to supplement their direct listing with a capital raise, providing those companies meet certain standards around the amount and value of new equity issued. This process, known as a “direct listing with a capital raise” more closely resembles a traditional IPO but it is still wholly different for reasons we’ll break down in the next section.

Direct Listing vs IPO

The key distinction between a direct listing and an IPO is that in a direct listing the company’s share price and allocation are determined by the market, rather than the company and its underwriters. In a traditional IPO, the company and its underwriters determine a share price and then issue and sell new shares at that price to a small group of institutional investors (known as a syndicate) before trading is open to the public. However, with a direct listing, no new shares are issued prior to the company’s public market debut and share price is driven solely by investor interest.

This distinction is important for a few reasons:

1. Market-driven price discovery in a direct listing can potentially lead to more volatility on the first day of trading. However, there is a growing debate around whether IPOs are intentionally priced lower to provide a more immediate “pop” for institutional investors.
2. Unlike an IPO, direct listings that do not involve a capital raise do not result in share dilution for existing shareholders.
3. In a direct listing, there is no “lock-up agreement.” This means that existing shareholders and investors are free to sell their shares on the public markets on day one of trading, rather than having to wait up to 180 days, as is typically the case in IPOs that have lock-up agreements.
4. An IPO will typically have underwriting fees which can range from 3% to 7% of the sale proceeds. This is to cover everything from the initial due diligence and pricing analysis to planning and participating investor “roadshows” and ultimately finalizing the share purchase agreements. Direct listings require less involvement from the underwriters, whom operate in more of an advisory role; this can sometimes translate to significantly lower fees paid to the investment banks.

Are There Any Distinctions Between Directly-Listed and IPO-Listed Companies?

While the initial listing process is different, companies that conduct direct listings are indistinguishable from other publicly-traded companies once they go public. They are subject to the same reporting and government requirements including annual reports (10-Ks) and disclosures to the SEC and their shareholders.

Companies conducting a direct listing must also go through the same SEC review prior to listing, meet the listing standards of whichever exchange they go public on, and file an S-1 registration statement before trading can begin.

Is a Direct Listing Right for Every Company?

Direct listings are still fairly nascent and companies considering them as an alternative path to the public markets should carefully weigh the pros and cons. Some of the key questions private company leaders should ask are:

• Is raising capital one of the key reasons the company is going public? If so, will the inability to raise capital (or raise capital only on the terms laid out in the SEC’s new rule) negatively impact the company’s growth plans?
• Is there a risk of not generating enough investor demand and generating an illiquid market for the company’s shares without the additional promotion and investor outreach provided by underwriters?
• Is market-based price discovery the right approach or is it more advantageous for the company and its board of directors to have the ability set the share price and offer shares to a select group of institutional buyers before opening trading to the general public?

How Morgan Stanley at Work can Help Support Direct Listing Success

A direct listing will have a considerable impact on multiple areas of a business, not least of which, the company’s equity plan.

The Shareworks Platform is one of the many workplace financial tools from Morgan Stanley at Work designed to help companies understand and plan for the equity impact of events like a direct listing through:

• A dedicated private to public strategy team to help you roadmap the transition of your equity plans to the public markets and prepare for trading on Day 1.
• Streamlined cap table management and help to ease the transition as the company prepares to go public.
• Auditable financial reporting that allows internal and external financial teams to conduct the due diligence they need leading up to the direct listing.
• The ability to help ensure compliance with geo-specific legal and tax regulations with Global Intelligence, an easy-to-use online database covering equity plans in over 170 countries.

Contact us to learn more about how Morgan Stanley at Work has helped thousands of private and public companies better manage their equity.