Direct Listing Vs. IPO: Key Differences
Initial public offerings (IPOs) and direct listings have become widely recognized methods of capital raising and are gaining traction in the investment banking world. IPO and direct listings are methods used by companies, to raise money on the stock market with an aim of increasing their market presence while enhancing their growth potential.
In the United States, companies usually go the traditional route of hiring an investment bank to sell their IPO. However, other companies are now opting for a direct listing, which eliminates the need for bankers and presents an alternative method of going public.
In this article, we’ll dive into the various differences between direct listings and IPOs and examine the key similarities and differences between the two.
What Is an IPO?
An Initial Public Offering (IPO) is a process whereby a formerly private company issues its shares to the public, allowing non-private shareholders to buy and sell the company’s stock. IPOs are typically the first time an issuer’s stock is offered for sale to the public. The valuation of the company is set during the IPO and the price is determined by signing a contract with an investment bank.
The issuer of the company typically goes through a process of long lead times when it comes to filing with the Securities and Exchange Commission, as well as due diligence evaluation on behalf of the prospective shareholders. Companies may decide to go public in order to raise capital, gain name recognition, gain liquidity, or pursue other objectives.
What Is a Direct Listing?
A direct listing is a less common alternative to an IPO, whereby a company’s shares are sold directly to the public, without the involvement of an investment bank or the services of an intermediary. A direct listing enables companies to quickly list their shares on an exchange, with minimal administrative costs and little or no dilution of existing shareholders.
Unlike an IPO, there is no share price set for a direct listing as the price is determined by the market and the investors’ perception of the market.
In addition, there is no need to go through the extensive process of filing paper work with the SEC, as well as due diligence evaluation by investment bank. This makes the process much more efficient.
Key Differences Between Direct Listing and IPO
Now that we’ve briefly explained the basics of a direct listing and an IPO, let’s take a closer look at the key differences between the two methods of listing.
- Process:
The first key difference between an IPO and a direct listing is the listing process. IPOs involve a lengthy process that typically entails a host of filings with the SEC and negotiations with investment banks and other intermediaries. Direct listings involve minimal administrative costs and paperwork due to its streamlined nature, as the company’s securities are made available in the market directly.
- Pricing:
Another key difference between IPOs and direct listings is the pricing mechanism. With an IPO the pricing is determined by the investment bankers involved in the process and the issuer and is agreed upon before the IPO. With a direct listing, the pricing is determined by the market through an auction process, allowing the stock to be traded without the involvement of banks or other intermediaries.
- Dilution:
One of the major benefits of a direct listing is that existing shareholders are not subject to dilution when selling their shares. This is because the existing shareholders can sell their shares directly to the public, bypassing the investment banks, resulting in minimal dilution. On the other hand, with an IPO the existing shareholders are subject to a certain level of dilution as the price of their stock may be determined by the issuing company, resulting in a dilution of their value.
- Liquidity:
IPOs provide companies with greater liquidity as the proceeds of the IPO can be used to improve the company’s cash position and also to purchase new assets. Direct listings, on the other hand, provide greater liquidity to existing shareholders as they can sell their shares directly on the market without having to pay for the services of investment bankers.
- Lockup Periods:
Lockup periods are another key difference between IPOs and direct listings. With an IPO, a lockup period is typically put in place, during which existing shareholders agree not to sell their shares for a certain period of time. With a direct listing, however, there is usually no lockup period. This allows existing shareholders to take advantage of current market conditions to sell their shares as soon as the listing takes place.
Initial Public Offerings and direct listings are two different methods of listing a company’s stock on the stock market. The significant differences between the two listing methods include the listing process, pricing, dilution, liquidity, and lockup periods.
IPOs involve lengthy filing with the SEC, as well as negotiations with investment bankers, while direct listings involve minimal paperwork and little or no dilution for existing shareholders. IPOs provide companies with greater liquidity and require their shareholders to abide by the lockup period, whereas direct listings provide existing shareholders with more liquidity and do not require the company’s shareholders to adhere to any lockup period.
Depending on the objectives of the company and the needs of the existing shareholders, one listing method may be preferred over the other. Future companies should educate themselves thoroughly and determine the best listing method for their business before making a decision.
