Slack chose to take its company public using a direct listing — something relatively rare on Wall Street.
Most companies opt for buzzy initial public offerings as a way of raising additional capital while also delivering a payday for prior shareholders.
Business Insider spoke with two experts — Haran Segram, an assistant professor of finance at the NYU Stern School of Business, and Phillip Braun, a professor of finance at Northwestern’s Kellogg Business School — to break down why founders would opt for a direct listing, and if two beloved brands doing so makes for a larger trend.
Why choose a direct listing?
In an IPO, a company will offer a certain amount of new and/or existing shares to the public. If a company has 100 shares, for instance, it might create 10 more shares that it sells for extra cash. The total number of shares thus becomes 110. In selling these extra shares to wealthy investors, IPOs help raise additional capital for company operations and expansion.
In a traditional IPO, underwriters — or banks that help shares of the company to investors — play a big role in marketing the company. Underwriters do the leg work of bringing in prospective suitors, including hosting “roadshows” that explain to investors why they should buy shares in the company.
But, as my colleague Troy Wolverton has written, with a direct listing, companies — or, rather, their early investors and employees — skip the middlemen. In that process, the existing stakeholders basically sell their shares directly to new investors once the company is listed. The company itself doesn’t raise any cash, at least not initially.
Banks do much less marketing with the direct approach. In the Slack listing, seven of the 10 banks that aided in the listing did virtually no work outside of committing to research coverage of the company, sources told Business Insider’s Becky Peterson.
Slack, however, did not need the money from an IPO: It became the fastest startup to reach a $1 billion valuation back in 2015 and reportedly raised $500 million in 2017.
Who wins out?
With a direct listing, employees and early investors looking to sell their shares can make money outright as a company goes public.
Employees, who often take shares during the early stages of a company to compensate for the lower salaries that come with working at a startup, might prefer a direct listing so they can quickly sell shares.
In an IPO, early investors must wait during the “lock-up period,” or a 90 to 180 days where they cannot sell their shares. Braun says employees may not prefer waiting, as markets could get too volatile and they’d make less off selling their stock.
“It’s definitely beneficial to do the entry offering for employees because they are more easily able to sell their shares, and they hope that they can sell them at a higher price,” Braun said.
The company can also save money through not having to pay banks marketing the company to investors as much. When banks help raise money for companies during an IPO, they can charge 2-8% of the total capital raised, Segram said. He estimates that Spotify saved $100 million through its direct listing.
What about the founders?
To Braun, the Kellogg finance professor, founders are largely indifferent as to whether their company opts for an IPO or direct listing, as they typically will not sell their shares right away, so there is no need for fast cash.
While existing shareholders (like employees) and early investors (like VC companies and private equity firms) looking to cash out may pressure the founder to opt for a direct listing to get a quicker return on their investment, the CEO’s investment will largely remain the same.
“The founder is relatively indifferent between whether they do a direct listing, an IPO, or don’t list at all,” Braun said. “They’re really going to see pressure [for a direct listing] from the venture capital companies that forced the sale.”
Will direct listings become more common? It all comes down to brand recognition
Pete Flint, a managing partner at a big-time San Francisco VC firm NFX, told Business Insider the IPO process costs the company too much money and is “inefficient.” “I am excited for this increasing trend for direct listings,” he said.
Experts, however, don’t know if a trend toward direct listing companies exists presently, or will eventually.
For one thing, only a very select group of companies really benefit from a direct listing. For an IPO, banks can bring smaller companies that don’t have the brand recognition of a Slack or Spotify to their network of prominent investors. But if you’re running a larger company, then going for the direct listing makes a lot of sense.
But still, bypassing an IPO remains a luxury many companies cannot afford.
“[Slack] was not waiting for the money coming from IPO to run their day-to-day operations,” Segram said. “It is a very selective group can do this direct listing, the major factor being the brand recognition.”
Braun, too, said the only two companies he’s seen opt for a direct listing were Slack and Spotify. He would not say these two companies constitute a trend that’s geared toward crushing the IPO market.
“It’s impossible to say, but I’d be surprised if it’s a pattern,” he said.