September 21, 2020
Direct Listings, an Alternative to Stock-based Initial Public
Offerings (IPOs)
Introduction
DPOs have largely been conducted by small-cap firms and
An initial public offering, or IPO, refers to the initial time
SEC-registered real estate investment trusts (REITs) that
that a private company offers its shares of stock to the
have listed on OTC markets. The NASDAQ stock exchange
general public to raise capital. After an IPO, the company’s
has reportedly completed about a half-dozen relatively
shares are traded in an open secondary market, such as an
small and obscure DPOs, whereas the New York Stock
over-the-counter (OTC) stock market or a stock exchange.
Exchange (NYSE) has listed Spotify and Slack. Exchange-
With the general decline in IPOs, an alternative approach to
listed firms face more rigorous requirements than those
public stock offerings has emerged—direct public offerings
listed on OTCs.
(DPOs). A DPO, called a direct listing or a direct
placement, is when a private firm’s shareholders sell their
Case Study: Spotify
shares on a secondary stock market, with the firm issuing
Spotify, the music streaming service, was founded in 2006
no new shares.
in Stockholm, Sweden. Now based in Luxembourg, the
firm was officially launched in October 2008 as an
Historically, stock-based IPOs were a significant means by
invitation-only service, but later adopted a “freemium”
which private firms raised funds for various reasons,
business model. It offers certain free features while
including capital, operational, and research and
charging for streaming subscriptions with added features.
development expenditures, and enabled owners to cash out.
As of June 2020, the firm had 138 million paid subscribers
Between 2000 and 2019, the annual number of IPOs
in more than 60 countries. It has continued to incur losses
reportedly declined significantly from 406 to 159. That
year over year, but somewhat less in recent years.
decline was part of the impetus behind the Jumpstart Our
Business Startups Act (JOBS Act; P.L. 112-106), which
Several factors reportedly drove the firm’s interest in
eased regulatory requirements for some aspects of IPOs.
conducting a DPO. Among them were an interest to provide
Researchers have identified a number of reasons for the
greater liquidity opportunities to its investors in exchange
drop-off, including (1) an expansion in external private
for their holdings of the firm’s private securities and a
funding for firms that previously might have opted for IPOs
desire to participate in a more universally accessible public
and (2) recent structural business changes that reduced
offering. In a traditional IPO, investment banks selectively
profits for small independent firms that heretofore might
allocate shares to their institutional investor clients. As is
have opted for IPOs, but instead were acquired by larger
typical of private shares, there was rather limited trading of
more profitable firms.
the firm’s private shares before the DPO.
Two recent potentially watershed IPO-related developments
To help it conduct the DPO, Spotify hired several
involved the novel use by two large private firms of a DPO
investment banks as financial advisors. They helped
as an alternative to an IPO. The two firms were Spotify, a
formulate its goals for the stock offering, navigated the SEC
Luxembourg-based music streaming firm, and Slack, a U.S.
securities registration process, and aided in planning for
domestic software firm. Unlike an IPO, a DPO avoids the
various public communications about the offering, among
traditional investment bank IPO underwriting support
other things. IPOs when compared to DPOs involve a more
wherein the banks buy an issuer’s stocks and sell them to
substantial and costlier role by the investment banks,
investors in their distribution networks. Such support can be
including acting as underwriters.
especially costly for smaller-sized firms. In the wake of
Spotify’s 2018 and Slack’s 2019 DPOs, discussion has
As part of new rules adopted by the NYSE in 2017 and
grown on the prospect that, especially for high-tech firms,
subsequently approved by the SEC, a company conducting
this alternative form of public offering may replace IPOs.
a DPO generally must file a resale shelf registration
statement. Such registrations require the company’s
Unlike publicly traded stocks, a firm’s private securities, or
shareholders to delay selling their registered company
private placements, are generally exempted from
shares until the initial trading day. Using this rule, as a non-
registration with the Securities and Exchange Commission
U.S. firm, Spotify filed the applicable SEC securities shelf
(SEC) if they are restricted to certain employees of the
registration form for foreign firms, Form F-1, which the
issuing firm, high net-worth investors, institutional
agency approved. On April 3, 2018, Spotify’s stock began
investors, and financial institutions. Such companies may
trading on the NYSE at $165 a share, which resulted in a
later conduct a DPO wherein a firm will list its shares on an
market capitalization of about $29 billion, surpassing a pre-
OTC stock market or an exchange. When trading in the
DPO projection of $20 billion.
shares commences on that secondary stock market, the
firm’s shareholders are then free to sell their shares.
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Direct Listings, an Alternative to Stock-based Initial Public Offerings (IPOs)
Perceived DPO Pros
underwriter share support. Some reporting suggests that
Observers have identified a number of potential benefits of
DPOs tend to experience comparatively greater initial
DPOs. They include the following:
stock price volatility than IPOs. An attendant concern is
that lacking such share support, first-day DPO trading
 The overall costs of conducting a DPO tend to be less
prices have a greater likelihood of significantly sinking
than that for IPOs because they do not entail generally
than do IPO prices. Reports indicate that neither Spotify
costlier underwriting. Some, however, have observed
nor Slack experienced any of these potentially
that particularly for large IPOs, the conventional
problematic first-trading-day scenarios.
underwriter’s cost is highly negotiable and frequently a
fraction of the traditional cost. Slack and Spotify also
 Some reporting suggests that liability risks for an issuer
paid fees to banks for advising on their DPOs. Slack
in a DPO are more limited than in a traditional IPO,
reportedly paid $22 million in such fees. Spotify
potentially narrowing opportunities for legal redress by
reportedly paid between $42 million and $49 million,
aggrieved shareholders. The limited risks are said to be
although part of these price tags may have derived from
because the issuer is not selling any of its shares to
the novelty of the deals.
investors; only its shareholders do so. Also, an IPO’s
underwriters are reportedly liable for misrepresentations
 Firms conducting DPOs have no limits on the firm’s
and omissions in the underwriting process. By contrast,
early investors, senior officers, and directors selling
some observers say that such legal obligations are not as
their shares. In a typical IPO, a lockup agreement
clearly established for the banks that advise on DPOs.
between an issuing company and its underwriters
stipulates that such sales may not occur for six months.
 Non-U.S. firms that conduct DPOs could have
diminished U.S.-based litigation exposure when their
 DPOs do not involve raising new capital, but after they
assets are primarily located outside of the United States.
are conducted, the issuer may be able to raise capital on
This could limit litigation-based monetary awards
favorable terms.
received by aggrieved shareholders. For example, in its
registration statement, Spotify described itself as having
 IPOs involve the issuance of new shares, resulting in
such diminished litigation exposure.
share dilution, which can reduce the value of existing
investors’ shares, thus reducing their proportional
 Some research argues that IPO underwriters perform a
ownership of a firm. With no new shares being issued,
critical gatekeeping role with respect to prospective
DPOs do not result in diluted shares, thus avoiding the
exchange-listed firms. The argument is that underwriters
aforementioned impact on the shareholders.
screen out firms that they project will not generate long-
term investor profits from firms that they project will.
 Firms that conduct IPOs are frequently said to leave
As a result, it is argued that because DPOs lack such
“money on the table”—the number of new shares an
roles for underwriters, investor protections are reduced.
issuer sells times the difference between the initial IPO
offer price and the first day of the trading closing price.
Emerging Developments
As a result of such initial IPO underpricing, an issuing
At present, there is a widely held view among practitioners
firm’s original investors incur an opportunity cost. Some
and observers that firms with an interest in conducting a
research reports that from 2000 to 2017, the aggregate
DPO that involves an exchange listing will generally be
amount of money left on the table for moderate-sized
confined to firms (1) with a public brand, like Spotify and
IPOs (between $25 million and $100 million in 2011
Slack, and (2) that do not need to raise new capital.
inflation-adjusted dollars) and large-sized IPOs (of more
than $100 million in 2011 inflation-adjusted dollars)
On August 26, 2020, the SEC approved a NYSE proposal
was $38.9 billion and $23.7 billion, respectively.
to allow firms that list on the exchange to conduct a DPO
Because DPOs do not involve the issuance of new
that would also enable them to raise new capital as in an
shares, firms that conduct them leave no money on the
IPO. The same month, the NASDAQ stock exchange, the
table.
NYSE’s principal competitor, requested SEC approval of a
broadly similar proposal to the one approved for NYSE.
Perceived DPO Cons
Observers have identified a number of potential
This more expansive type of DPO would allow a firm’s
disadvantages of DPOs. They include the following:
initial shareholders to sell their shares, while also enabling
the firm to raise new capital by selling newly issued shares
 An IPO typically involves underwriting investment
to the public. Some observers think that the new structure
banks doing something called book building, which
may help to expand corporate interest in conducting DPOs.
involves the banks ascertaining signs of interest in the
issuing firm’s stock at various price levels to arrive at
Gary Shorter, Specialist in Financial Economics
both an IPO size and share price. Also, as part of an
Raj Gnanarajah, Analyst in Financial Economics
IPO, the underwriting banks may acquire additional
issuer shares to help stabilize share prices when trading
IF11653
begins. DPOs involve neither book building nor


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Direct Listings, an Alternative to Stock-based Initial Public Offerings (IPOs)


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