Popular cryptocurrency exchange Coinbase went public on Nasdaq on April 14 using a direct listing. The company achieved a huge valuation (more than $100 billion) in this offering. While it’s too early to tell whether Coinbase’s stock price will hold up over time, the initial success of this offering is impressive. This continues a string of successful direct listing offerings by large technology companies such as Slack, Spotify, Palantir and Asana, all of which utilized this process to become public companies. What is a direct listing and how is it better (or worse) than a traditional IPO? More importantly, should you use a direct listing to take your company public? (Spoiler alert:  maybe not).

Direct listing is a somewhat rare process in which a company achieves public company status without using traditional underwritten IPO sales efforts. Historically, only the company’s existing shareholders were allowed to sell shares in a direct listing. The company would not receive any of the proceeds of the offering as it would not be allowed to issue new shares, and accordingly all funds would go directly to the selling shareholders. On December 22, 2020, however, the SEC approved a rule change proposed by the NYSE that allows a company to conduct a primary offering through a direct listing under certain circumstances. Nasdaq later submitted a similar proposal which is currently under SEC review but which should be approved, as it is substantially similar to the NYSE proposal. This should fuel even more interest in direct listings going forward.

Probably the biggest advantage associated with a direct listing is its relatively low cost. Avoidance of underwriters’ fees and commissions can result in a significant cost savings for the company, although there will still be legal, accounting and other costs for a direct listing. Shareholders who participate will be able to sell their shares at market trading prices rather than at an initial fixed price as in a traditional IPO, which may also be very advantageous to them. A “reference price” will be set, but the actual price could be quite higher. For example, in the Coinbase deal the reference price set by Nasdaq was $250 per share, but no shares were sold at that price. The share price opened at $381 and increased to $429.54 before closing at $328.28 on day one.

If the company elects to use a direct listing without issuing any new shares, the absence of dilution may also be good for the shareholders. Further, the direct listing process tends to happen more quickly than a conventional IPO, as there is no lengthy road show or similar process. Recent direct listings have also contained less onerous lockup restrictions on executives, directors and significant shareholders as compared to traditional IPO lockups, which can be onerous.

There are some potential disadvantages with a direct listing, however. The ongoing stock price may be volatile and could fluctuate broadly, especially in the early days after the direct listing. Additionally, by its nature a direct listing may involve sales of stock by insiders, some of whom are very familiar with the company’s condition and its chances of success. They may have a variety of legitimate and valid reasons for selling their stock, but investors and others may wonder why these insiders are selling. This situation could be made worse by the general lack of significant lock-ups or similar restrictions in a direct listing. Some parties (including SEC Commissioners Lee and Crenshaw) also believe that the lack of an underwriter and associated due diligence review in the direct listing context will reduce desired investor protections, especially in primary direct listings where the company sells shares.

This direct listing process is part of a paradigm shift that is occurring in capital raising. Companies are increasingly raising larger amounts of capital in the private markets, and the public markets are being forced to adapt and innovate. A similar dynamic has been seen in the overwhelming popularity of mergers of private companies with public SPACs, which are driven by their speed and the relative ease with which they can be done as compared to a conventional IPO. I don’t anticipate that direct listings and SPAC mergers will replace IPOs any time soon, but they are definitely having a significant impact. Look for this to continue and intensify.

Direct listings are an intriguing alternative, but they are not right for every company. Direct Listings must comply with a complex set of regulatory and securities exchange requirements.  From a practical standpoint, a company considering a direct listing should have a visible and popular public presence, since no sales program will occur. This normally involves well-known, consumer-facing businesses with easy to understand business models that essentially “sell themselves”. A loyal existing customer base, for example, could be advantageous for a direct listing if these customers already believe in the company and its prospects and want to become shareholders. If you are thinking about taking your company public we urge you to carefully consider all of the various available routes to public status, as they all have advantages and disadvantages, and discuss them with your advisors. Your company’s unique situation will determine the best approach.