IPO vs. direct listing is a tortoise vs. hare story

6 minute read
IPO vs. direct listing is a tortoise vs. hare story


SEC filings are complex endeavors that require extensive financial disclosures and due diligence to ensure maximum transparency and investor protection – and each vehicle to go public has its pros and cons. Let’s review the three vehicles to go public and their unique benefits.

Although Wall Street is not Main Street, it is an essential driving force that makes America’s version of democratic capitalism the envy of the world. Wall Street generated dynamic funding resources that helped convert hundreds of small businesses into international commercial powerhouses. Apple Inc., HP, Facebook and Spotify are fledgling garage concepts that grew into major corporations thanks to Wall Street.

Wall Street is all about making money for companies and investors by creating innovative financial instruments that drive revenue. Direct listings, for example, turned heads among investors as they offered cost-effective alternatives to traditional IPOs and SPAC/De-SPAC transactions.

SEC filings are complex endeavors that require extensive financial disclosures and due diligence to ensure maximum transparency and investor protection – and each vehicle to go public has it’s pros and cons.

Let’s review the three vehicles to go public and their unique benefits.

What is a traditional IPO?

A traditional IPO filing allows growing companies to “go public” by issuing stock shares with the help of investment banks like JPMorgan Chase or Goldman Sachs. Selling shares is a complex endeavor tightly regulated by numerous state and federal laws that require extensive financial disclosures and due diligence to ensure maximum transparency and protection for investors.

To cope with all the legal and financial hurdles, companies issuing IPO filings use those investment banks to help underwrite (guarantee the sale), market the offerings, determine the initial share price and assist with the entire sales process. The shares are then listed on one of the top stock exchanges, like NYSE or NASDAQ, and traded by individuals and other institutional investors. 

While a bit slow and cumbersome, the tortoise (IPO) has several advantages including:

  • Enhanced marketing exposure supported by big banks
  • Price visibility and comprehensive due diligence
  • Ability to raise large amounts of capital with high liquidity
  • Underwriting guarantees that all shares will be sold

These companies went public via traditional IPOs in 2022:

What is a SPAC?

A SPAC is known as a publicly traded shell company specifically designed to acquire or merge with another company. A SPAC gets cash from an IPO and uses that money to acquire a small private company to take it public. SPACs are managed by highly experienced executive teams who use their expertise and extensive business networks to identify potential acquisition targets.

Once a target company is identified and vetted, a SPAC’s current shareholders vote on the proposed acquisition and offer the targeted company an alternative to a previously available standard IPO. The advantages of participating in a SPAC include:

  • Having a fast and efficient way to raise capital 
  • Gaining a strong, experienced and well-connected management team
  • Gaining access to a broader range of non-cash corporate resources, like facilities and technologies

There were 613 SPACs in 2021, but only 86 in 2022; three examples include:

Why direct listings gained mind share

A company uses a direct listing when it decides to go public without using an investment banker like Goldman Sachs to underwrite its shares or conduct M&A filings. Direct listings let a company’s existing shareholders, employees and core investors sell their shares directly to the public on a stock exchange. While this innovative process doesn’t issue any new shares, or raise any new capital, it does provide alternatives to traditional IPOs by granting the company more control over share prices and lowering the cost of capital. However, direct listings may pose some risks for investors since there’s no “lock-up period” for price stabilization that standard IPOs provide. Companies travel the direct listings road for a variety of reasons, including:

  • The share price is dynamic and set by the market – not a bank
  • Current shareholders have direct participation
  • Fast liquidity – no 180-day “lock-up” period
  • Avoids most underwriting fees
  • Has lower marketing and advertising costs
  • Deters litigation since fewer people/groups have legal standing to sue

The SEC first authorized direct listings in 2018 to help invigorate the soft IPO market. This allowed strong companies like Spotify to raise $30B, while unicorns like Coinbase, Warby Parker and Slack also raised significant interest and public mindshare. But the smart money was divided on what it all meant. Did direct listing’s innovative approach drive the market or did the hot product offerings and solid revenue forecasts drive the market? Was the rabbit sprinting past the turtle at last? 

The debate centered around two competing facts: While there have been only 13 direct listings since 2018, their average market valuations rose by 64% compared to 27% for standard IPOs. However, the desperately slow COVID-effected 2021 year gave the market a chance to put a microscope on the direct listing phenomenon. What they found wasn’t pretty since direct listings:

  • Are a slowing market because investors realize that only strong, well-capitalized companies with solid market upsides and proven business models are true direct listing candidates. These companies also have exceptional marketing and sales teams that don’t need investment banks to push their shares.
  • Lack the transparency, due diligence protections and access to future M&A filings or institutional investor opportunities that regular IPO filings provide
  • Limit opportunities to sell when/if market conditions improve down the road
  • Face increased SEC, NYSE and NASDAQ scrutiny caused by trading and management problems with high-risk rollouts like Coinbase and Palantir

The limited scope and range of direct listings effectively relegate these IPOs to a specialty market where only the strong survive. In addition, this segmented specialty market is more exposed to swings in Federal Reserve monetary policies and are much more sensitive to interest rate fluctuations than De-SPAC and M&A filings. 

In December 2022, the SEC and NYSE tried to spur flagging interest in direct listings when they approved rule changes that eased pricing limitations by letting the opening auction price be within 20% below and 80% above the price set on the initial registration. Unfortunately, it was of little help; no direct listings were registered during the first two months of 2023. 

These significant factors point to this conclusion: The hare is fast but isn’t sturdy enough to run in a world regulated by SEC filings, Wall Street, NYSE and risk-averse investors. The tortoise, however, is winning the race because it understands that slow, sure and smooth equals fast in the long run. On Wall Street, there are no shortcuts. 

Rely on the experts at Toppan Merrill

The market experts at Toppan Merrill are well-versed in the key differences between the various investment vehicles and what document and regulatory requirements apply to your specific IPO needs. Learn how Bridge provides fast and accurate SEC, EDGAR and iXBRL filings, and how SOX Automation technology can help you navigate the rigors of ongoing SOX compliance.

To reach the experts at Toppan Merrill visit ToppanMerrill.com or call 800.688.4400.

Toppan Merrill

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