Capital Markets Market Trends

Direct listings: Sidestepping the traditional IPO

Project management software provider Asana and data analytics and consultancy firm Palantir directly listed their shares on the NYSE on September 30th, bypassing the traditional IPO method. By excluding underwriters, (historically) selling pre-existing shares and thus raising no new capital, direct listings in the past have been best suited to high profile and well-funded companies like Slack in June 2019 and Spotify in April 2018. However, the difference between direct listings and an IPO may soon be blurred. In August, US securities regulators granted the NYSE approval for firms to raise new shares alongside selling pre-existing shares through a direct listing, although objections from the Council of Institutional Investors have since called for a review into the decision.

The process

Direct listings, prior to the US securities regulators recent decision, issue no new shares in the company to be sold. They provide liquidity for founders, vested employee shareholders and initial investors, as their shares can be sold freely in the public market. In this way, direct listings are a niche route into the public market and are well suited for well-known names that do not need to raise vast sums of additional capital given their prominent and long-term investors. Both Palantir and Asana match this profile. Palantir was founded 17 years ago, raising billions of dollars in that period whilst Asana was founded by Facebook co-founder Dustin Moskovitz 12 years ago. 

Furthermore, the price of shares in a direct listing is not negotiated beforehand but rather determined solely by supply and demand. Palantir shares opened at $10 per share, exceeding the $7.25 reference price set by the NYSE, before falling to $9.50 to finish its opening day. Nor does the process involve a “lock-up”, which is a time period during a traditional IPO when existing shareholders cannot sell their shares to prevent an overly large supply of shares depressing the stock price.

Why would firms choose a direct listing?

IPO critics have censured the expensive processes employed by investment banks, who typically earn as much as 7% of proceeds on a new listing. Dustin Moskovitz, Asana CEO, provided reason for the choice of Asana’s direct listing, stating that “the cost of capital was lower”. Banks have also been under fire for the under-pricing of stocks in an IPO, with a first day “pop” indicative of the fact that shares could have been priced higher and more capital raised. Half of all 100+ firms that have gone public in the US this year have experienced a first day “pop” of over a 20% rise in share price. Venture capitalist Bill Gurley, a frequent critic of IPOs, believes that the current system is “systematically broken and is robbing Silicon Valley founders, employees and investors of billions of dollars each year”, in a way handing first day gains to investors not companies. Following the US securities regulators decision, direct listings now offer an alternative route to both go public and raise capital, avoiding the high costs of banks and risks of under-pricing.

However, direct listings at the same time carry a number of risks to the firm. By not issuing new shares, the listing ensures that company founders can retain very tight control. Palantir’s filing with the SEC highlighted how control would be retained by the company’s three founders as well. The founders would keep control, with 40% of the share of votes, even if their combined stake in Palantir fell to only 6% from the current 30% of total shares that the three founders own. In this way, direct listings may raise concerns over corporate governance, particularly in Palantir’s case given its involvement in sensitive software matters for governments and militaries. Many tech companies have recently agreed to limits on such distorted voting shares. Slack and Peloton founders will retain control for only 10 more years, Zoom’s founders for 15, and yet Palantir’s tilted voting structure is set to stay in place until the last of the founders dies. 

Volatility is also a major risk to firms undergoing direct listings. Without the use of investment bank intermediaries, there is no support or guarantee for the share sale or price, no promotions, and no guaranteed reliable long-term investors. While Asana ended the first day of trading with a market value $3bn higher than its last private valuation, Palantir fell victim to this unpredictability. Its value fell short of private valuation estimates from five years ago by $4bn, despite having initially surged more than 10% and having recorded a 49% increase in revenue for the first half of 2020 compared to the previous year.

Could direct listings become commonplace?

Although the US securities regulators decision over direct listings appears to expand the playbook that firms have at their disposal to go public, it is unlikely that direct listings will see a significantly greater uptake in the future. Lisa Buyer, an IPO adviser in Silicon Valley, recognises this, stating that she “is completely puzzled by the concept of a company that wants to directly raise capital, perhaps take on significant incremental liability, and have no say whatsoever over the share price or the first round of shareholders”. Investment banks certainly provide value to firms looking to raise additional capital through an IPO: matching firms with stable long-term investors, and agreeing on a share price and “lock-up” period that minimises the risks of volatility. Further to this, the innovation that investment banks are introducing to IPO processes may further nullify the potential advantages of a direct listing. For example, Goldman Sachs, acting as the lead underwriter for video games software company Unity, helped raise $1.3bn through a system whereby investors submitted the prices they were willing to pay for stock into a portal that allowed Goldman Sachs to set the share price after bids came in. 

Whilst it is yet to be seen how the change to direct listings may impact the process of going public and raising capital for firms, the stability, advantages and innovation that investment banks provide to their clients will likely ensure that traditional IPOs remain standard practice.


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