Reading: Alternative Going Public Strategies

The following main considerations are typically relevant in the context of a direct listing:

No Fresh Capital for the Firm

• The firm does not issue any new shares; it merely lists the shares of its existing shareholders. Therefore, a direct listing does not provide any fresh capital for the firm.
   
• Because the firm raises no fresh capital, the ownership stake of existing (non-selling) shareholders is not diluted.

Liquidity to Original Shareholders

• The main purpose of a direct listing is to give existing shareholders an opportunity to sell (some of) their shares to public investors.
   
• Assuming there is sufficient demand for these shares, public transactions could be an attractive exit alternative because they can be executed in much smaller tranches than typical private deals, and they might carry a more favorable valuation because there are no (or smaller) discounts for lack of liquidity.

No middle men (underwriting syndicate)

• A direct listing cuts out the middle men. Unlike a traditional IPO, in which investment banks play a crucial role in the underwriting of the firm's shares (see section Initial Public Offering), there are no investment banks involved as underwriters. This has potentially far-reaching implications for the firm and the market.
    
• Significantly lower costs: As we have seen in the discussion of the costs of going public, the investment banks who form the underwriting syndicate are generally the largest cost block. They often account for 70% or more of all direct costs associated with the IPO. By cutting out the middle man, firms can save these costs, which makes the going public significantly less expensive. However, while they save the costs of the investment banks, they also forego the potential benefits these banks bring to the table!
    
• No primary investors: Moreover, the shares "simply" start trading on the secondary market without first placing them with interested investors on the primary market. This saves the firm the so-called underpricing. At the same time, they forego the potential benefits from the roadshow and the bookbuilding with the primary investors.

Information asymmetry

As we have argued, there is significant information asymmetry between the listing firm and the investing public, as privately held companies are often not on the radar of institutional and private investors who trade on public markets. In a traditional IPO, one of the main tasks of the underwriting syndicate therefore is to put the listing firm on that radar and to make sure that it is well received by the market.
   

• Publicity: Absent the roadshow of the IPO and the other marketing efforts by the underwriters, a direct listing therefore generally receives less publicity and attention than a traditional IPO.
     
• Reputation: Moreover, it is also not "certified" by a consortium of well-known investment banks and "anchor investors" who vouch for the quality of the listing firm with their reputation.
    
• Valuation uncertainty: An important task of the underwriting syndicate is to determine the "fair" value of the firm's shares by soliciting bids from potential investors (bookbuilding). Without these real market tests, it becomes much more difficult to determine the price at which the firm's shares should trade. The listing firm might indicate a price range at which its shares have sold in the past in private over-the-counter (OTC) transactions, but the resulting range is generally large.
    
• Aftermarket support: Finally, there is also no support from the underwriting syndicate after the going public, including additional research, analyst coverage, or price/liquidity support. Simply put, the firm is on its own.

Listing Requirements

Needless to say that direct listings are subject to the same listing requirements as "ordinary" IPOs. Therefore, this listing route is only open to firms that fulfill these criteria without the work of the underwriting syndicate and the participation of new primary investors. 

Most notably, many privately held firms have less than 1 million shares that are held by investors with less than 10%, and they also have fewer than 300 round lot holders. Such firms would therefore not qualify for a going public according to the standards set forth by NASDAQ capital market.