Advantages and Disadvantages of Direct Listing Compared to IPO

What is a Direct Listing?

A direct listing is a process whereby a company goes public without engaging underwriters and issuing new shares. Instead, the existing shares of the company become available for trading on the stock exchange. This approach allows shareholders, including founders, employees, and early investors, to sell their stake on the open market immediately following the listing.

Direct listings are particularly appealing to companies that already have significant market recognition and do not require additional capital. Examples of successful direct listings include companies such as Spotify, Slack, and Coinbase, which opted for this route to avoid substantial costs and maintain flexibility when entering the stock market.

Key Differences Between Direct Listings and IPOs

1. Capital Raising

   • In an IPO, companies issue new shares and sell them to investors, allowing them to raise capital for further development. This is the primary means of financing growth and expansion.
   • A direct listing does not involve the issuance of new shares, so the company does not receive additional funds. Instead, existing shares become publicly tradable.

2. Role of Underwriters

   • In a traditional IPO, underwriters play a crucial role in helping to establish the offering price of shares, allocating them to investors, and supporting the market in the early days of trading.
   • A direct listing does not require the involvement of underwriters, which reduces the company's costs for the offering. However, this also means a lack of market support at the beginning of trading.

3. Cost of the Offering

   • IPOs come with high costs for underwriters, legal services, and marketing. Underwriter fees can range from 5-7% of the funds raised.
   • A direct listing is cheaper as the company avoids expenses related to underwriters and extensive marketing campaigns aimed at attracting investors.

4. Stock Pricing

   • In an IPO, underwriters set the initial price of shares, often below their market value, to ensure demand for shares on the first day of trading.
   • In a direct listing, the stock price is determined by market demand and supply, which can lead to higher volatility in the initial trading days, as there is no pre-established price.

5. Lock-Up Period Restrictions

   • Traditional IPOs often include a lock-up period, which can last up to 6 months, during which early investors and employees cannot sell their shares.
   • A direct listing does not impose such restrictions, allowing shareholders to freely sell their shares from the very first day of trading.

Advantages of Direct Listing

1. Cost Savings
   A direct listing allows companies to avoid the high costs associated with underwriters and ancillary services. For companies seeking to enter the market with minimal expenses, this can be a significant advantage.

2. No Capital Dilution
   Since no new shares are issued in a direct listing, the holdings of existing shareholders remain unchanged. This is important for founders and early investors who wish to retain control over the company.

3. Flexibility in Selling Shares
   A direct listing does not restrict early investors and employees from selling shares, allowing them to liquidate their holdings in the market immediately after listing. This is particularly important for companies with active employee stock option programs.

4. Establishing Fair Market Price
   The stock price is formed based on market demand and supply, which helps avoid undervaluation of the company, a common issue in traditional IPOs.

Disadvantages of Direct Listing

1. No Capital Raising
   A direct listing does not allow the company to attract additional funds, which can be a disadvantage for firms needing capital for expansion.

2. Increased Volatility in Initial Trading Days
   Without support from underwriters, shares may experience increased volatility at the outset of trading. This could deter some investors and lead to significant price fluctuations.

3. Lower Marketing Impact
   Unlike an IPO, a direct listing does not include a marketing campaign or "roadshow," which may reduce investor interest in the company.

4. Risks for Shareholders
   The absence of a lock-up period may lead to a sudden increase in share supply in the market if early investors wish to sell their holdings immediately after the listing. This could pressure share prices.

Examples of Successful Direct Listings

In the U.S. market, successful examples of direct listings include companies like:

• Spotify (2018): A music streaming service that opted for a direct listing to minimize costs associated with going public and avoiding capital dilution.
• Slack (2019): A corporate communications platform that chose a direct listing for more flexible market entry and to ensure liquidity for existing shareholders.
• Coinbase (2021): A major cryptocurrency exchange that opted for a direct listing to capitalize on the cryptocurrency market's growing popularity and attract investor attention.

These examples show that a direct listing can be an effective solution for large and well-known companies that already possess a robust business model and do not require raising new capital.

The Direct Listing Market in Russia: The CarMoney Example

In the Russian market, direct listings are much rarer than in the United States, and there are few examples of such placements. However, in 2021, CarMoney, a company specializing in auto collateral loans, successfully completed a direct listing on the Moscow Exchange. It became one of the few Russian companies to adopt this method of market entry.

CarMoney executed a direct listing without engaging underwriters and issuing new shares, allowing existing shareholders to sell their stakes on the open market. This approach enabled the company to enter the exchange with minimal costs, avoiding expenses related to a traditional IPO. This decision was driven by the company’s stable financial position and a desire to maintain management flexibility.

The CarMoney example illustrates that direct listings are feasible in the Russian market, even though such occurrences remain infrequent. The limited number of direct listings is associated with the lower liquidity of the Russian market and companies' preferences to attract capital via traditional IPOs.

When to Choose a Direct Listing?

A direct listing is suitable for companies that already have a significant financial position and do not need to raise additional capital. It is also a good option for firms with a strong market presence and a well-known brand, which do not require marketing campaigns to attract investors.

Additionally, a direct listing may benefit companies that wish to avoid capital dilution and retain control over their business and provide stock options to employees through incentive programs.

Direct listings and IPOs are two distinct approaches to entering the stock market, each with its own set of advantages and disadvantages. A direct listing can be a more cost-effective and flexible means of going public, but it does not allow for raising new capital and may lead to greater volatility at the beginning of trading. The choice between these methods depends on the company's goals, financial status, and investor attraction strategy.

Corporations should carefully assess all the potential risks and benefits before selecting the appropriate method for entering the stock market.