The Direct Listing Craze

Since 2019, we have witnessed the rise of the Direct Listing. Though they are not exactly new structures, following the heavily-publicized Direct Listings of tech giants Spotify and Slack, they have captured the imagination of the capital markets world. Venture capitalists love them. CFOs are intrigued by them. Bankers want to hang out with them. Securities lawyers are fearless of them. And, accountants, well, they mostly roll their eyes at them. They are everywhere. Howling in the hills, whispering in the wind, psst!’ing from hastily revised pitch books. If you want to get into a Direct Listing seminar, you have to call on Tuesday morning between 9 and 9:15 am, at least a month out. The point is that Direct Listings are kind of a big deal.

And they should be. The growing sophistication and breadth of private financing alternatives, combined with the mounting frustration at inefficient IPO pricing and market volatility at the very outset of trading, have made traditional IPOs a love-hate affair for investors and companies. Liquidity is fun and zesty, but its charms are often overset by the arbitrary whims of an unequal supply and demand curve. Plus, for the tech Supercorns, doing an IPO just isn’t what it used to be. To a tech Founder, the hallowed sanctum of old Wall Street (and its once-apotheotic IPOs) isn’t exclusive entry into some gilded mansion party. It’s closer to a full day at the DMV, exacerbated by the frustrating knowledge that she could probably create and launch an app in about two weeks to handle the entire process in a few mindless swipes.

More than that, with increasingly notable stock “pops” in technology IPOs, companies are wary of leaving money on the table at IPO pricing by setting the price too low. Direct Listings avoid the shame of hindsight scrutiny. Better to let complete market dynamics (whose capriciousness is too providential to demand apology) decide the day, rather than arbitrary convention and countervailing and conflicting self-interests. Particularly for companies that have plenty of money on the balance sheet, Direct Listings provide (as of March 2022) a very appealing alternative and avoid dilution (prior to working through details with the SEC on primary share direct listings that have a pathway at the stock exchange level) and the other potential downsides of an IPO.

With all the innovative energy associated with Direct Listings, they may appear at first to be more different than they really are. Legally, they are pretty similar to a traditional IPO, including:

• Similar legal and financial disclosure requirements;
• 2-3 month SEC review process;
• Adopting governance policies and programs to meet SEC and listing requirements;
• Marketing efforts to build support in Wall Street for post-listing trading;
• Similar publicity and Section 5 concerns when “in registration”;
• Engaging sophisticated financial advisors to inform trading and pricing;
• Significant diligence processes to assess the material risks of the business and inform comprehensive disclosure to investors; and
• Securities Act liability for accuracy of disclosure in the registration statement.

Despite these similarities, there are definitely some fundamentally different aspects that companies will want to carefully consider before deciding to pursue a Direct Listing. Accordingly, we (and posterity) strongly advise that companies carefully read the following (and then call your attorney with any questions): 10 Key Considerations for Direct Listings

The two technology Direct Listings have kicked off this trend (Slack and Spotify) and those that were quick followers in the Fall of 2020 (Asana and Palantir) were very similar in terms of process and structure. As Direct Listings become more prevalent, we will certainly see more bespoke versions. For example, companies have been considering private placements of stock shortly before listing, in which they have more control over the potential dilution and it can be used to help determine the reference price for listing. In December 2020 the SEC approved an NYSE rule to provide the bases for companies conducting Direct Listing to also sell primary shares to the market. As of March 2022, Nasdaq has a corresponding proposed rule pending before the SEC. Although there is significant plumbing to be worked out with the SEC before issuers effect primary share Direct Listings, we believe that these pending efforts will ultimately result in structures that combine some of the best qualities of both IPOs and Direct Listings.

To that point, we suspect the primary catalysts behind Direct Listings will begin to trigger changes in some IPOs. For example, to get the benefits of immediate liquidity that we see in some Direct Listings, we may start to see shorter, staggered or more limited lock-up agreements in IPOs. A company, for example, could allow all holders to sell a portion of their shares immediately (e.g., 25-50%) to satisfy early trading demand and increase initial trading volume, while keeping some shares back to potentially aid in stabilization. Staged lockups have been utilized in the past frequently based on aftermarket trading price performance but in 2020 Unity Software included a staged lockup release, including a small number of shares eligible for immediate sale, without a trading price performance hurdle. Similarly, IPOs could include only secondary shares to avoid concerns over too much dilution and pricing inefficiencies. Companies could look to a private placement just before or concurrently with a listing with investors with increased control over pricing and investor selection. Finally, for companies that do not want to spend weeks with potential investors pitching their stock, we may see shorter roadshows and/or Investor Days like that seen with Direct Listings, or shorter “virtual” roadshows that are done remotely.

All in all, Direct Listings are a great development. They have illuminated real concerns about IPOs and give companies another alternative in the seminal process of becoming a public company. Plus, in case you haven’t read any actually interesting blogs on the topic, I will clue you in that many pre-IPO/listing investors really like them. Like all great new technologies, they strive to solve deficiencies in a system that continues to evolve. We think they are here to stay and that many investors and companies will grow to love them.