Direct Listing vs. IPO: What’s the Difference?

You may have heard of something called a direct listing in recent months. The workplace collaboration software company Slack used one in June 2019 when it decided it wanted to list its shares. The music streaming service Spotify also used one to go public in 2018.

So what is a direct listing?

A direct listing—sometimes called a direct offering—is a way for a company to sell its shares to the public without involving any middle men, or intermediaries.

It’s different from an initial public offering (IPO), where the company relies on an investment bank to take it public. Such a bank is called an “underwriter,” because it assumes much of the risk associated with the IPO.

With a direct listing, company executives, early investors, and employees who own equity, or shares, are given the option to convert them into a public stock and then sell it to the public through a stock exchange such as the New York Stock Exchange or the Nasdaq. (These stakeholders are not obligated to sell their shares, however.)

Wait, what’s an IPO again?

An IPO is the first time a company sells its shares to the public through an exchange.

When a company wants to open new stores, build or acquire a factory, or expand in some other way, it may need additional resources to pay for it. Company executives may use an IPO to raise additional capital to invest in and grow their business.

Often a company does not yet have enough internally generated funds to finance such projects. Going public is one way to raise a relatively large sum of money in a relatively short period of time.

Companies typically use investment banks to underwrite the shares that will be sold to the public. That means the company relies on the bank to set the opening price of the shares before they start trading. This can cost a lot of money—we’re talking potentially millions of dollars.

Direct listing vs. IPO

Here are some other ways a direct listing differs from an IPO.

• With a direct listing, the stock exchange sets the starting trading price. It’s called an “initial reference price,” and it’s based on new investor demand for the shares. In contrast, the underwriters set what’s known as an “opening price” in a traditional IPO, through a process called a roadshow.
• There isn’t a lock-up period in a direct listing. A lock-up period is typically a period of time—usually about six months—where company insiders aren’t allowed to sell their stock. When a lockup expires, that can make the stock of the newly public company more volatile. With a direct listing, a company insider may sell their shares right away.
• By doing a direct listing, the company also isn’t “diluting” its shares, or potentially making them less valuable by creating more of them. Often in the traditional IPO process, the investment bank handling the IPO will create more shares to sell to the public.
• In contrast to a direct listing, the investment bank underwriting an IPO often creates an over-allotment of shares to sell to the public if demand for the stock becomes too great. That can smooth out price volatility. Such a practice doesn’t exist in direct listing.

As in a traditional IPO, companies pursuing a direct offering are still required to file paperwork about the listing with the Securities and Exchange Commission (SEC). You can find out more about any publicly listed stock on the SEC’s website EDGAR. Part of your due diligence as an investor should involve examining paperwork associated with a new filing.

Remember the Stash Way—invest for the long-term, invest regularly, and don’t put all of your eggs in one basket.