If you want to give your investors a chance to cash out, an initial public offering may not be the best option. After receiving approval from the Securities and Exchange Commission, the New York Stock Exchange is offering a way for some private companies to sell shares in a so-called direct listing and/or a traditional IPO. Not to be outdone, Nasdaq is seeking SEC approval for a similar financing route, according to the Wall Street Journal.
My advice? If your company offers a very well-known product or service that has attracted a considerable amount of capital -- such as Spotify or Slack Technologies -- then a direct listing could be a better option. If your company is not well-known, an IPO is a better, albeit more costly, option.
Direct Listing: Definition, Advantages, Disadvantages
A direct listing allows private companies to sell shares to the public without intermediaries. The company makes a certain number of shares available for members of the investing public to purchase at a price set by a negotiation between the buyer and the company, according to Stanford Law School. Once the shares are sold, the company's fluctuating stock price becomes available to anyone who wants to buy or sell it.
The advantages of a direct listing are straightforward. The company can provide liquidity to its investors -- which include capital providers and some of its employees -- without paying millions of dollars in fees to an investment bank. Direct listings also allow companies to avoid lockup periods that bar insiders from selling their stock -- often for six months.
The disadvantages of a direct listing could be significant or irrelevant depending on your company. To be sure, if you do a direct listing or an IPO, you will need to pay lawyers and accountants among other professionals to help you produce a prospectus for the shares you're selling. And in both cases you will need to produce quarterly financial statements and talk with investors and the media about them every quarter.
If your company is well known by the public and you do not need to raise new capital to keep your business afloat, a direct listing may be a good route with few disadvantages. However, if your company is not well known and it does need to raise new capital, then a direct listing may not be right. A direct listing will not help create demand for the stock of a less well-known company, nor will it enable the company to raise new capital.
IPO Definition, Advantages, Disadvantages?
In an IPO, companies cede control to an investment bank. The bank helps create demand for the shares by hosting so-called road shows in which management makes the case for purchasing the shares offered in front of the bank's favored clients -- such as mutual funds and institutional money managers.
The bank gauges demand for the shares right before the IPO and sets a price range. In addition, when the shares start trading, the bank monitors the stock price. If demand for the stock is weak, the bank buys the shares in a bid to make sure that the company's stock closes above its offering price.
An IPO is more costly than a direct listing. Investment banks charge underwriting fees that range from 7 percent of capital if you raise less than $100 million down to 3.5 percent for offerings exceeding $1 billion, according to PWC.
An IPO's more significant costs come as a result of the way the investment bank markets the company's shares. Typically, the bank sets the initial trading price of the stock below where it expects the price to end the day and sells those lower priced shares to its favored clients.
The bank justifies this by pointing out that if the shares of the company rise significantly on the day of the IPO, it will create more demand for the shares from investors who missed out on the previous day's trading.
While that could happen, two other outcomes are nearly certain. The bank's favored clients will enjoy a risk-free first-day IPO trading pop when the shares become available later to the general public. And the first-day pop costs the share-issuing company capital that it would have raised were its offering price set at a higher level.
To be sure, the IPO remains popular. It offers experienced guidance to founders who have not done IPOs in the past, it raises new capital for the company, and it makes the public more aware of the company. In addition, if the stock price drops on the first day, the bank's role as a "stabilization agent" could be vital for the company, noted the Journal.
It's good for company to have both options. Pick the one or the combination of the two that best meets your company's needs.