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TechCrunch Conversations: Direct listings

Last April, Spotify surprised Wall Street bankers by choosing to go public through a direct listingprocess rather than through a traditional IPO. Instead of issuing new shares, the company simply sold existing shares held by insiders, employees and investors directly to the market bypassing the roadshow process and avoiding at least some of Wall Streets fees. That pattens is set to continue in 2019 as Silicon Valley darlings Slack and Airbnbtake the direct listing approach.
Have we reached a new normal where tech companies choose to test their own fate and disrupt the traditional capital markets process? This week, we asked a panel of six experts on IPOs and direct listings: What are the implications of direct listing tech IPOs for financial services, regulation, venture capital, and capital markets activity?
This weeks participants include: IPO researcherJay R. Ritter (University of Floridas Warrington College of Business), Spotifys CFOBarry McCarthy, fintech venture capitalistJosh Kuzon (Reciprocal Ventures), IPO attorneyEric Jensen (Cooley LLP), research analystBarbara Gray, CFA (Brady Capital Research), and capital markets advisorGraham A. Powis (Brookline Capital Markets).
TechCrunch is experimenting with new content forms. Consider this a recurring venue for debate, where leading experts with a diverse range of vantage points and opinions provide us with thoughts on some of the biggest issues currently in tech, startups and venture. If you have any feedback, please reach out:Arman.Tabatabai@techcrunch.com.



Thoughts & Responses:





Jay R. Ritter



JayRitter is the Cordell Eminent Scholar at the University of Floridas Warrington College of Business. He is the worlds most-cited academic expert on IPOs. His analysis of the Google IPO is available here.

In April last year, Spotify stock started to trade without a formal IPO, in what is known as a direct listing. The direct listing provided liquidity for shareholders, but unlike most traditional IPOs, did not raise any money for the company. Slack has announced that they will also conduct a direct listing, and it is rumored that some of the other prominent unicorns are considering doing the same.
Although no equity capital is raised by the company in a direct listing, after trading is established the company could do a follow-on offering to raise money. The big advantage of a direct listing is that it reduces the two big costs of an IPOthe direct cost of the fees paid to investment bankers, which are typically 7% of the proceeds for IPOs raising less than $150 million, and the indirect cost of selling shares at an offer price less than what the stocks subsequently trades at, which adds on another 18%, on average. For a unicorn in which the company and existing shareholders sell $1 billion in a traditional IPO using bookbuilding, the strategy of a direct listing and subsequent follow-on offering could net the company and selling shareholders an extra $200 million.
Direct listings are not the only way to reduce the direct and indirect costs of going public. Starting twenty years ago, when Ravenswood Winery went public in 1999, some companies have gone public using an auction rather than bookbuilding. Prominent companies that have used an auction include Google, Morningstar, and Interactive Brokers Group. Auctions, however, have not taken off, in spite of lower fees and less underpricing. The last few years no U.S. IPO has used one.
Traditional investment banks view direct listings and auction IPOs as a threat. Not only are the fees that they receive lower, but the investment bankers can no longer promise underpriced shares to their hedge fund clients. Issuing firms and their shareholders are the beneficiaries when direct listings are used.
If auctions and direct listings are so great, why havent more issuers used them? One important reason is that investment banks typically bundle analyst coverage with other business. If a small company hires a top investment bank such as Credit Suisse to take them public with a traditional IPO, Credit Suisse is almost certainly going to have its analyst that covers the industry follow the stock, at least for a while. Many companies have discovered, however, that if the company doesnt live up to expectations, the major investment banks are only too happy to drop coverage a few years later. In contrast, an analyst at a second-tier investment bank, such as William Blair, Raymond James, Jefferies, Stephens, or Stifel, is much more likely to continue to follow the company for many years if the investment bank had been hired for the IPO. In my opinion, the pursuit of coverage from analysts at the top investment banks has discouraged many companies from bucking the system. The prominent unicorns, however, will get analyst coverage no matter what method they use or which investment banks they hire.



Barry McCarthy





Barry McCarthy is the Chief Financial Officer of Spotify. Prior to joining Spotify, Mr. McCarthy was a private investor and served as a board member for several major public and private companies, including Spotify, Pandora and Chegg. McCarthy also serves as an Executive Adviser to Technology Crossover Ventures and previously served as the Chief Financial Officer and Principal Accounting Officer of Netflix.
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