SEC green-lights direct listing on NYSE
5 min read 29 Dec 2020, 10:33 PM ISTSEC ruling permits direct listings on the NYSE, which provides companies another route to raise capital, and investors another platform to pick out high-potential companies
PremiumLast week saw the US Securities and Exchange Commission (SEC) approve the New York Stock Exchange's (NYSE) 'direct listing' plan. This will allow prospective public companies to raise money by selling shares directly to investors without requiring a middleman. NASDAQ also wants to offer businesses this option and has filed a similar direct listing proposal with the SEC.
The direct listing process allows companies to become public without having to go through the traditional initial public offering (IPO) process. Conventionally speaking, unlike an IPO where new shares are issued, underwritten, sold, and allotted to the public, already existing shares are made available for the public to purchase without the need for underwriters in the direct listing process. Up until now, direct listings were rare, with American regulators only permitting companies to directly list and sell early investors', founders', or employees' existing shares, never new ones. However, after this ruling, the NYSE is adding the option for newly issued shares to be priced in an opening auction by itself or alongside existing shares.
Direct listings also forego the requirement of a lock-up period. While the SEC does not require that IPOs have a lock-up period, it is normally seen in many IPOs, including the recent Wish (ContextLogic) IPO. Lock-up periods usually last between 90 - 180 days after an IPO, depending on the company, during which existing shareholders are not allowed to redeem or sell their shares in the public market. This is done to prevent volatility and allow the stock's true value to be found, as the price of the stock would decrease should there be a large supply of shares entering the market.
The most significant offering that the direct listing process provides to companies is the option to jettison the middleman underwriter, which is usually a big investment bank, and instead directly list on the NYSE. The main benefit companies derive from this is cost savings as underwriters may charge anywhere between 3 -7% of the IPO's value, which can be worth hundreds of millions of dollars. It is worth noting that advisory fees are still paid to investment banks in a direct listing, albeit to a much lesser degree than what would have been paid for underwriting services.
In a traditional IPO, newly issued shares are priced according to the agreement between the issuer and the underwriters. However, as noted earlier, there are no underwriters while raising capital through a direct listing. The initial price is established in a transparent process where the whole market can participate during the auction. Theoretically, this should provide companies opting for the traditional IPO route with certainty about how much they will raise ahead of their IPO, while companies pursuing capital raises through direct listing will only know how much they have raised when their shares start trading.
However, traditional IPOs have come under scrutiny of late, particularly following a stream of first-day pops in high profile IPOs such as that of Airbnb, Zoominfo, and DoorDash. IPO pops are the occurrence of the company's initial share price seeing large increments relative to the original IPO price on the first day of trading. The companies could have sold their shares for more right from the IPO's inception. It reasons that this would have happened if the company had let their potential investors set the price through a direct listing. The traditional IPO process has also been criticised for its long marketing time and high fees at different points.
While this new direct listing model might be cheap, it does have its downsides. Underwriters will usually promote the business to potential investors during what is called a 'roadshow' and even secure investors in advance in a traditional IPO. Further, traditional IPOs offer shares of the company in question to a select group of heavy-hitters before hitting the stock exchange. However, direct listings skip this step, and the promotional process is entirely on the aspiring public business in a direct listing. Additionally, the lack of an underwriter, which acts as the gatekeeper of the traditional IPO process, means that there is no entity that vets the company's financials in detail or ensures that the disclosures the company makes around its initial listing are accurate. Investors often take security in and are reassured by the credibility of the vetting process by investment banks and are likely to feel more comfortable to put an investment down. In a direct listing, it is not easy to obtain this level of clarity. Underwriters also protect the company's share price from too much volatility in the early days of trading.
Intuitively, it seems like start-ups could benefit greatly from the direct listing ruling. However, while direct listings have cost benefits, it might not be right for all start-up companies. Companies that are already well-established and capable of cultivating buzz around going public without underwriters will benefit most from the direct listing option. New start-ups need decent recognition, mind share, and market share before considering a direct listing. This might be obtainable by a consumer-facing start-up, but this becomes much tougher for business-to-business start-ups. These companies might not always command much exposure outside of their niche areas of expertise. In cases such as this, IPOs might be the way to go despite being more expensive.
While this ruling benefits companies across all industries, in addition to NYSE's general listing standards, there specifically exists a minimum direct listing requirement in the NYSE. Companies opting for this route must either sell a minimum of $100 mn of newly issued shares in the direct listing or have a combined public float of at least $250 mn in newly issued and existing shares. Companies planning on a direct listing are still required to file a prospectus with the SEC and make all SEC-mandated ongoing public company disclosures after the direct listing completion.
There are now three ways to go public: traditional IPOs, direct listings, and special-purpose acquisition companies (SPACs). SPACs, also known as blank cheque companies, are incorporated with no commercial operations and are formed only to raise capital through an IPO to acquire an existing company. While it seems most likely that IPOs will remain the most popular option for companies wanting to go public, the process is now democratised, with each route having its own set of risks and benefits. Companies need to analyse which route fits their needs the best.
These different routes are sure to aid the capital market's general health as having a greater choice is always good.
