On June 20, 2019, Slack listed its shares on the New York Stock Exchange under the symbol WORK. Slack did this through a direct listing versus the traditional initial public offering (IPO). How are the two different?
A direct listing is exactly that: a direct listing of company shares on a public stock exchange. Let’s understand the major differences between this and a traditional IPO.
No bankers, no fees: In a traditional IPO, the banker's role would be to coordinate a road-show with potential investors to gauge demand for the newly issued shares and build a book of orders (“building the book”), which determines the IPO price. In a direct listing, the road show is replaced by an investor day, on which the company speaks with a group of investors. However, there is no solicitation of orders since no new shares are issued. The banker does not determine the price; the market does. Consequently, the fees of a direct listing are a fraction of even the lowest IPO fees. Typically investment banks will charge 4-7% of the gross proceeds and another $4M in additional costs. This adds up considerably.
For example Zoom raised $340.8 million during its IPO and incurred $28 million in underwriting fees and offering expenses. Uber's IPO of $8.1 billion cost a whopping $106 million in underwriting fees and offering expenses. Slack did a direct listing and did not incur these fees.
Open and Equal Access: In a direct listing, every investor has access to shares of the company. Whether you are buying 1 share or 1 million shares, are a trillion dollar hedge fund or a small retail investor, each and every investor has equal access to the direct listing.
During an IPO process, bankers are the ones to decide who to sell shares to based on client relationships. Most of the time, only a handful of institutions (e.g. hedge funds or mutual funds) have meaningful access to the shares of an IPO. Unsurprisingly, the institutions with the highest allocations to shares are also the bank's most lucrative clients that generate the most fees. A small retail investor has little chance to invest in an IPO other than a few shares that might be allocated to their brokerage firm — even smaller hedge funds have little access.
Market-Based Pricing: In a direct listing, the pricing model is based on market-based pricing principles. The same technology and methodology used to price any stock on a regular trading day is used to price a direct listing and is governed by the laws supply and demand.
Unfortunately, the pricing process for an IPO is opaque and usually mispriced. Bankers "build the book" and give share allocation based on the relationship with their clients — not on supply and demand. Only a small percentage of the company's shares, around 10-15%, are offered to be sold during an IPO process, which artificially lowers supply. In addition, bankers are known misprice the shares of and IPO and target an oversubscribe amount of 20x, meaning for every share they sell at the IPO price, 20 other buyers would have bought the same shares at the same price. This by definition undervalues the shares of the company. As a result, there is artificial demand for the shares on IPO day, usually resulting in a jump in share price, known as the "IPO pop." The pop generates huge profits for IPO investors, who also happen to be the bank's most lucrative clients. At the same time, this means the shares were underpriced and the IPO over-diluted the company's shareholders — essentially creating a wealth transfer from the shareholders to the bank's institutional clients.
Bill Gurley, partner at Benchmark, has been advocating direct listings to startups, and explains it well here.
No lockup period: In a traditional IPO, existing shareholders, management and investors agree on a lock-up period of 90–180 days. This means they cannot sell any shares until the lock-up period is over. In a direct listing, this period does not exist, which means that early investors, management and employees can sell their shares immediately. By doing this, they may put selling pressure on the stock early on.
No capital raised for the company: In a direct listing, existing shares are traded on the stock exchange. This means no new shares are issued and no new capital is raised for the company, as it happens in a traditional IPO. Generally, only companies with enough capital to grow and a strong balance sheet will do a direct listing.