Traditionally, a company “going public” meant it was debuting through an initial public offering (also known as an IPO). And while an IPO is still the route most companies choose, we’ve seen some tech unicorns opt for a direct listing in recent years.
In this article, we breakdown the differences of each method and the trade-offs a company makes when opting for either option.
What is an IPO?
In an initial public offering, a private company offers new shares to the public, enabling the company to raise new capital and scale operations.
In order to undergo a public offering, the company will typically approach one or more investment banks for underwriting services. An underwriter helps the company prepare for the IPO in a number of different ways, including advising on share price and filing the correct paperwork with the SEC. The underwriter will also go on a roadshow to create excitement and help establish a public market for the shares, eventually culminating in the final price for the IPO.
For Uber, which made its public debut in May, the roadshow included major financial hubs across the world, including London. There, CEO Dara Khosrowshahi spoke to more than 100 investors about the future of Uber, the company's plans to expand the food delivery service, and new areas of business. On the day of its IPO, the final price of each share was $45 and the company raised $8.1 billion.
Although companies are able to tap into a larger variety of investors with an IPO, there are still risks of not raising the amount of capital needed. In addition, hiring underwriting services can be costly—an underwriter normally receives five to eight percent of capital raised during an IPO.
What is a direct listing?
In a direct listing (also known as a direct public offering), the company lists existing shares rather than issue new ones and raise new capital. This eliminates the need for a roadshow or underwriter, which saves the company time and money.
Historically, this method has been used primarily by budget-conscious small businesses seeking to avoid the abundance of fees associated with traditional IPOs.
However, Spotify challenged that precedent. The wildly popular music streaming service demonstrated that large businesses are also worthy candidates for a direct listing by betting that sheer investor demand and enthusiasm would keep its stock price from collapsing in the absence of an underwriter. Instead, to prepare for its direct listing, the company hired several advisors for a flat fee, keeping costs down.
Additionally, direct listings give shareholders the opportunity to sell their stake in the company as soon as it goes public, without experiencing the holding period they normally would with an IPO. This can also help avoid the dilution that issuing new shares could cause.
But, there are risks associated with removing the safety net underwriters and lock-up periods provide. Without an intermediary, there is no guarantee that the shares will sell and it can be more difficult to protect against volatility.
To help mitigate some of the risks, companies like Spotify have turned to secondary transactions. Secondary transactions give shareholders the chance to sell equity before a direct listing and provide a level of price discovery, which may reduce early market volatility.
To learn more about how companies get to the IPO or direct listing stage, check out our guide to understanding the private markets.