The NYSE proposed in November (here) changes to its listing standards to allow “primary” share offerings through a direct listing (see commentary here, here and here). To date, direct listings have been in the form of stockholder share resales (a “secondary offering”) and not a capital-raising sale of company shares (a “primary offering”). The NYSE changes would have eliminated two listing standard obstacles to a primary offering: (1) the outright ban (a pretty big obstacle) and (2) the requirement that the issuer have 400 round lot shareholders when it lists. The SEC, with astounding alacrity, said “nope” (see here and here). The SEC hasn’t explained why it rejected the NYSE’s proposal, but because primary direct listings are of interest to some heavy hitters, and because stock exchanges make money when shares are listed, count on stock exchanges continuing to work with the SEC to make primary direct listings a thing.
In case you made it to this sentence and are thinking “what?!?”, some background and a primer on direct listings follows.
A “direct listing” is the direct sale of shares to the public without intermediary sales to an underwriter or others. Ever since Spotify did one in 2018, direct listing has been a hot topic. Among the touted benefits of a direct listing:
- Avoiding underwriter fees and discounts. (But Spotify still paid $35 million in advisory fees to Morgan Stanley and Goldman Sachs for help with its direct listing. That’s not nothing, but it’s probably lower than the 5-7% discount typically charged by an underwriter in a traditional IPO.)
- Ensuring (maybe) that any stock market “pop” benefits existing shareholders and not initial IPO investors. (Underwriters typically underprice IPO shares to ensure the stock trades up and that initial IPO purchasers that buy directly from the underwriters, and that underwriters will count on to buy shares in subsequent offerings, make money. That’s just the way it’s done.)
- More immediate liquidity for existing shareholders, who are not subject to lockups, as they are in a traditional IPO, and who may sell without worrying about Rule 144 safe harbor requirements.
- A vague sense that you are innovative and an even vaguer sense that by doing a direct listing you are sticking it to the Man.
Among the detriments:
- Less market management, and potentially a higher burden on the company to educate analysts and investors. (Although, one presumes at least part of the $35 million paid by Spotify went toward this.)
- The potential for a choppy entry into public markets since you don’t have pre-arranged initial purchasers.
- The potential that this is only really an option for well-known companies like Spotify that don’t need to engage in marketing for investors to enthusiastically buy their shares.
Commentary on direct listings generally is here and here, and a case study on Spotify’s direct listing is here.
Each of the NYSE and Nasdaq previously modified their listing standards to make secondary direct listings easier for companies like Spotify. Although it had been possible for private companies to list on the NYSE if they could demonstrate that they had $100 million in public float based on an independent valuation and the most recent trading price on an established trading system for unregistered securities, Spotify didn’t have a sufficient record of trading activity under the NYSE’s rules to adequately establish a trading price. That led the NYSE to do what any self-respecting stock exchange clamoring to list Spotify’s shares would do: it changed the rules (here). The changes eliminated the trading activity requirement for a company valued at $250 million or more, but also tightened independence requirements for valuation firms and required that direct listings be made only in connection with a registration statement filed with the SEC, which is subject to SEC review. Nasdaq similarly modified its rules for direct listings in early 2019 (here) and, last week, tweaked them again (here).
Direct listings are not new, terribly innovative, or actually much different from traditional IPOs: a company still must file a registration statement that contains a lengthy prospectus to register an offering with the SEC, engage in a prolonged due diligence process, spend lots of time and money getting its corporate governance and accounting processes up to snuff, and educate the investing public (but sure, no underwriting agreement or lockup agreements to negotiate). It’s also not clear whether primary direct listings will be used much, even if the NYSE succeeds in making them available, as long as private equity money is a readily available alternatives. Nonetheless, Spotify’s direct listing has made them seem new, and stock exchanges will keep working to accommodate their use in primary offerings. So now you know.