Last year saw music streamer Spotify Technologies SA seek and obtain a direct listing on the New York Stock Exchange without raising any money by way of an initial public offering (IPO). With Slack Technologies Inc., the workplace messaging company, looking to follow suit later this year, could this route to accessing stock markets, without the additional costs of an IPO but allowing investors to exit, prove popular?
When Spotify sought its direct listing in April 2018, it opted not to offer any new shares, instead citing the desire to allow existing shareholders the opportunity to freely sell their shares on the open market. Executives at Spotify maintained that it did not need to raise capital to fund growth. It sought to list its shares to fulfil a promise to original investors that they would have the opportunity to cash in their investments.
Initially it appeared that Spotify failed to convince enough shareholders to sell following its direct listing; too constrained a supply would have artificially boosted its share price to an unsustainable level, inviting volatility to its share price. After trading opened however, Spotify’s shares traded efficiently and with relatively little volatility. Spotify shares opened at $165.90 per share, above the reference price of $132 a share. Whilst the price dropped by the end of the first day of trading by 10 per cent. to $149.01 each, the value of the company was $26.5bn; this put Spotify in the top 10 largest US tech listings.
The benefits of a direct listing primarily stem from cost savings and flexibility. In a traditional IPO, banks and brokers are responsible for marketing the new issue to investors and/or underwriters. Their fees for this can range from 3 per cent. to 7 per cent. of the money raised. Consequently, an IPO can become more expensive the more money that is raised but the company does not get greater net funds.
Spotify chose to list without a traditional 90 to 180 day lock-up period; this in itself could eliminate the short selling hedge funds undertake before the lock-up period expires. In addition, direct listings create a channel for early investors to make efficient exits while still allowing a company to raise money through follow-on offerings or selling convertible bonds if required.
Though there are clearly a number of benefits to companies from direct listings, there are still significant associated downsides – such as volatility and missing out on the glamour and publicity of an IPO.
Without the stabilising bids and lock-up periods of an IPO, opening prices and early trading days are left entirely to the whims of the market.
IPO business models are designed to create an uptick in valuation by building awareness about a company and drumming up excitement in the market. This can be lost in direct listings.
In the UK, an admission of shares on AIM by a business which has not been independent and traded for at least two years requires its directors and key shareholders to agree to a lockup period of one year from the admission of securities; in all other admissions and listings (including on the main market) similar lockups have become market practice. The purpose of the AIM rule, and resulting market practice, is to ensure that directors and key shareholders of a company show commitment to the business and that they do not take unfair advantage of any uplift in the share price created by admission at the expense of other investors.
Direct listings may only be best suited for companies that, like Spotify, already have significant brand recognition, do not need to raise additional capital and already have a diverse institutional investor base. Slack Technologies made its filing with regulators to go public in the US earlier this month and whilst the contents of the filing are confidential it would appear that it thinks it can comfortably fit this profile.
Kamalprit Lally is a senior associate, corporate and financial services and Kendal Youngblood is a paralegal at law firm Wedlake Bell