It's Too Early to Pronounce Direct Listing Supremacy over IPOs
Do Direct Listings Complement IPO Route?
A backer seeks a return on investments. No newly incorporated company can quickly raise capital from the public, and hence, venture capitalists (VCs), private equity (PE) firms and other seed capital providers come into play. Most VCs and PEs run a for-profit business. Profit booking is the cornerstone of investment. How easily and quickly can the backer book profit by liquidating holdings shapes most investment decisions.
The Securities and Exchange Commission (SEC) recently greenlit Nasdaq’s proposal, allowing companies to raise fresh capital by using the direct listing route, which a few experts believe can make the traditional initial public offer (IPO) route obsolete. The SEC’s stance builds on the momentum that kicked off in the last month of 2020 when a similar proposal by NYSE received the regulator’s nod. In theory, this means companies can go public without appointing investment banks as underwriters. Listing has become quicker and easier.
Arguments in Favor of Direct Listing
This progressive stance of the SEC brings many advantages. Take, for example, tech startups and their financial backers. Many entrepreneurs have withdrawn from their startups, which have become S&P 500 companies, and are now backing new ideas. Some of these new ideas are truly revolutionary, such as self-driving cars and research in biotech. VCs and PEs provide the much-needed capital at different stages, hoping to reach the exit stage with enough return on investment. Even when it does not involve raising fresh capital, a direct listing is a convenient way to liquidate holding and exit the company.
Another argument in favor is the frequent return of capital by companies taking the IPO route.
Lufax Holding, headquartered in China and listed on the NYSE, recently announced a stock buyback program of its American Depository Shares (ADS). The stock that the company will buy back was listed just a few months ago via the IPO route. Lufax is a cash-rich entity that took the IPO route not to raise fresh capital but to allow its investors to exit their positions. Companies including Spotify and Slack opted for the direct listing route and achieved this intended goal expediently, without worrying about the idle capital raised via the IPO route.
The direct listing comes with an inherent game-changing attribute. Roblox, an online gaming portal, perfectly used this primary utility of direct listing. In March 2021, the company went public on NYSE, and the listing allowed existing investors to sell their holding instantly in the absence of any lock-up period. Roblox’s market debut was rewarding in other aspects too. When the gaming firm’s stocks were acquired in January by private backers, each share was worth US$45. In contrast, direct listing catapulted the company’s status, with each share trading for US$64.50 on listing day. While the uptick in market value can be attributed to increased demand for the company’s services, going public widens the pool of investors, leading to a boost in the wake of intense competition.
IPOs Yet to Lose Shine
IPOs are not losing steam, at least for now. In the first two months of 2021, money raised by special-purpose acquisition companies (SPACs) was already half of what was raised in 2020. In December, the SEC liberalized the space of raising new money by tweaking the direct listing rules. However, until recently, it did not lead to a daunting impact in the IPO universe. Experts were wary that the change could lead to the imminent death of the traditional IPO, something that is yet to come true. In contrast, 2021 has been a stellar year for SPACs, and money raised in January outshined money raised in entire 2019. It may be a possibility that companies and advisers are yet to understand and embrace the direct listing route.
Some critics of direct listing have cautioned on cutting off investment banks or underwriters, intermediaries that play a critical role in the IPO universe. Removing these ‘middlemen’ can have its own set of disadvantages. For example, investment banks carry out the company’s due diligence planning to go public via the IPO route. They also hold ‘road shows’ and market the company to large investors by employing their unique and expert ways. As underwriters, they act as brokers and charge a fee to ensure a smooth landing on the listing day. Direct listing does away with these underwriters, and although it means saving on time and money by companies, it may be prejudicial to concepts like investor protection.
Direct listing is picking up slowly. The IPO route has yet to suffer a significant impact from the SEC’s liberalization. Presently, the sample size is too small to analyze the complete picture. With time, more companies will utilize this route to at least let private investors liquidate their holding, if not for raising fresh capital. Once the sample size grows and is comparable with the IPO universe, we can genuinely assess direct listing’s supremacy over IPOs.