Direct listings attract interest as market awaits primary pioneer

05 April 2021 - 12:48 pm UTC

by Jay Antenen, Tom Cane and Troy Hooper

It will likely take a bold company willing to invest the time and effort to go through a lengthy consultation with securities regulators before the market sees the debut of a primary direct listing, advisors said. 
 
Advocates tout direct listings as more efficient and less expensive than traditional IPOs since shares are sold at a price set by the market instead of a book building process led by investment banks. This reduces the chance that sellers leave money on the table if a stock pops on the first day of trading. 
 
Since Spotify [NYSE:SPOT] conducted the first secondary direct listing in 2018, a handful of tech companies have gone public through the structure, most recently digital game platform Roblox [NYSE:RBLX] in March. 
 
So far, all direct listings in the US have involved the secondary sale of shares held by issuers’ existing shareholders. That has limited the structure to companies that want to go public in order to offer liquidity to owners and employees rather than as a means for raising capital.
 
Late last year, the SEC approved the New York Stock Exchange’s proposal for how a company can sell new shares in a direct listing in order to raise capital. The securities regulator is currently reviewing a similar proposal from rival Nasdaq.
 
Greg Rodgers, a partner at Latham & Watkins who advised Spotify, said executives at the music streaming company recognized the benefits of a direct listing and committed the time to overcoming the hurdles posed by the then novel approach to going public.
 
Finalizing the NYSE rule for a secondary direct listing encompassed only a small portion of the legal work necessary to bring Spotify to market, he said. Spotify approached Latham in May 2017 and went public in April 2018, according to case study published by the law firm.
 
“There is likely some other innovative company that’s not in a big rush. But it is hard to predict when that pioneer will present itself,” said Rodgers of the type of firm that will pursue the first primary direct listing.
 
NYSE Vice Chairman John Tuttle said some companies are interested in exploring the option and are working with the NYSE, SEC and other advisors to “blaze a trail.” He predicted that within five to seven years, direct primary listings will represent a meaningful percentage of all public offerings.
 
For 2021, advisers said they expect a number of companies to pursue secondary direct listings, with sectors broadening out beyond technology to areas like healthcare and insurance. 
 
“There are dozens of companies considering a direct listing at the moment. How many will actually pursue it remains an open question. What is interesting is that many companies are seeing the benefits,” said Tuttle. 
 
Apartment ListAxonius and Roofstock are among the late-stage startups that have told this news service that they see a direct listing as one of the potential options they could use to reach the public market. 
 
Warren Lazarow, a partner at O’Melveny in Silicon Valley, said direct listing advocacy by well-known venture capitalists like Benchmark Capital’s Bill Gurley is an important factor in giving companies confidence to pursue the option. 
 
To be a good candidate for a direct listing, a company optimally would be well known among investors even if it is not a household name, said David Segre, a partner at Cooley who advised on software group Asana’s [NYSE:ASAN] direct listing last year.
 
A reasonably high profile can be critical since a company has to arrange its own investor meetings without the help of financial advisors in order to comply with SEC rules meant to prevent market manipulation, Segre said. 
 
There can be a concern that if potential investors do not believe a company is a must-own stock for their portfolios, they will not spend time studying the name ahead of a listing where there is no certainty they will receive an allocation of shares like they would in a traditional IPO, he noted.
 
SEC restrictions on coordination between a company and its financial advisors pose a dilemma in a primary direct listing since the company itself is a major seller and its views on valuation need to be taken into account when gauging the level of supply and demand for shares, Segre said.
 
The NYSE’s plan for a primary direct listing calls for a company to set a price range ahead of the offering and commit to selling shares within this range. The firm’s designated market maker will then conduct an auction on the day of the listing to determine the price within the range that shares are sold.
 
“We have more row to hoe before there are any direct listings with a capital raise,” said Segre. He said a company may have to seek a no action letter from the SEC, either as part of its direct listing or ahead of it, which would add significantly to the overall timeline.
 
Latham’s Rodgers said that a company may have limited incentive to go through the time-consuming process when it can more easily raise capital in the private market ahead of a secondary direct listing and then through a 144A convertible note offerings in the months afterwards. Spotify and Slack Technologies [NYSE:WORK] both used this approach when they went public through direct listings.
 
The SEC is currently facing an onslaught of filings for IPOs due to the record number of SPACs, straining staff charged with reviewing the submissions, officials have said. The regulator has slowed down some rulemaking as it prioritizes processing all of the filings.