Direct listings onto the stock market have been a recent trend among Silicon Valley startups lately, with many entrepreneurs considering it a quick and convenient way to raise capital.
However, even though this is a method that has been employed by tech giants like Spotify
On one hand, an IPO involves the following: First, a company would file an S-1 with the Securities and Exchange Commission. This would then be approved or not depending on financial stability and relevant accounts. Then, the company would clearly define their target range for how much capital it wants to raise with the IPO. After that, it sets a price range for price per share, settles on a price and then sells a block of shares for that price to institutional investors. Once this process is complete, then a company can officially launch an IPO.
On the other hand, a direct listing is a cousin of an IPO, with the same ultimate outcome without all the preliminary steps. That is, a direct listing will not set any price targets for its shares and wade into the water with institutional investors: instead, it launches its shares directly at market, without any real gauge for demand or accuracy in pricing.
"A traditional IPO involves underwriters and other professionals with deep knowledge of the company-and clear legal obligations-helping to set the terms," said Tyler Gellasch, executive director of Healthy Markets Association, an investor group. "With a direct listing, the legal obligations of those setting the prices are not as clear. That's a new risk for investors."
A key difference here is thus that there are no underwriters involved in a direct listing. A lot of what the underwriter does is to determine the initial offer price of the shares, smoothen out the process of dealing with regulatory requirements, purchasing the available shares from the company and then selling them to investors via their own established distribution networks.
Hence, it makes sense for a company to pursue a direct listing if it already has a very established brand and market presence. Even then, both Slack and Spotify did not fare well with their initial direct listings. Though Slack went public in June, its stock has plummeted by 42%, while the S&P 500 has climbed 9.5%.
Direct listings thus come with extreme risk, though they are less costly, while IPOs are more secure. Investors are thus wary of the former.
