Spotify and Slack Technology were listed in a slightly unusual way called ‘Direct Listing’. Airbnb, a vocational rental online marketplace company is also set to be listed directly no later than year, is also considering listing directly. Investors may heard of IPO a lot, but the concept would be quite unfamiliar. What are the advantages and disadvantages of direct listing? What made Spotify and Slack to choose untraditional way of ‘Initial Public Offering’?
Traditional IPO
IPO means that the company's shares officially begin selling on the Stock Exchange. Being a listed company means that it has become one of the large and reliable companies whose shares are quoted on a stock, so many companies strive for it. The usual method of listing is to raise funds by issuing new shares and selling them on the market. The process is called IPO, Ant-financial raised $34.4 billion recently.
Advantage of direct listing
If listed directly, the process of raising funds through the issuance of new shares will be omitted, and only the listing process will be carried out only to sell the shares held by existing shareholders on stock exchange. New investments will not be raised, but it has the effect of officially trading process as normal listing companies do. The advantages are below:
Firstly, direct Listing saves the cost. IPO process costs a lot of money. Seven percent of the funds secured by the IPO are usually paid as commission to the security companies that handled the process. Price of stocks exchanged during IPO is usually measured higher than normal, which likely to have more commission fee to the security firms. For example, if a company raises one billion dollars by IPO, the fee costs over 200 million dollars.
Second, existing investors can sell their shares right after listing. For traditional IPO, there is usually a 180-day limit on the sale of shares that are held by existing investors to protect prices. So existing investors or executives and employees with stock options can't make a profit no matter how much the price goes up for six months. However, in the case of direct listing, there is no such restriction, so the existing shares can be traded right away.
Furthermore, additional financing is also available. Unlike IPO, it is not possible to raise funds once it is listed, but further fund raising is possible through the issuance of new shares. Furthermore, the cost of it is much cheaper. According to Spotify CFO, additional financing was available at a 1% discount on transaction fees and a 4% discount on sales.
Finally, it has effect on rewards to existing investors. As startups grow, the employers promise their employees a share reward, such as a 'stock option', but if they don't go public, they'll be useless. Of course, there is alternatives if the company is acquired by another company, but it's hard for a fairly large company to do so. A listing is required to compensate employees and investors who worked for a startup. Unlike the IPO, there is no issue of new shares, so the value of the existing shares is not diluted.
Disadvantage of direct listing
There are many advantages of direct listing, but there are limitations and disadvantages as well. Above all, direct listing is only possible for companies that are well-known and whose business models are widely known. To do IPO, companies need to attract investors. So, the companies have to be often mentioned in the media, like Spotify and Slack.
IPOs have the effect of forcibly supplying the market with a few dozen percent of all stocks, but there is no guaranteed volume for direct listing. When existing shareholders can supply sufficient quantities, demand including institutional investors can be activated and normal transactions can continue.
And most of all, there should be no need for financing. In the past, large-scale financing was difficult without IPOs, but these days the venture capital market has grown big enough, and startups have been able to raise funds through various methods.
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