The NYSE has filed with the SEC a proposed rule change that would allow companies going public to raise capital through a primary direct listing. Under current NYSE rules, only secondary sales are permitted in a direct listing. As a result, thus far, companies that have embarked on direct listings have been more of the unicorn variety, where the company was not necessarily in need of additional capital. If approved by the SEC, will the new proposal be a game changer for the traditional underwritten IPO?
Essentially, a “direct listing” involves a registered sale, currently only by selling shareholders, directly into the public market with no intermediary underwriter and—imagine this—no underwriting commissions (just advisory fees) and no roadshow or similar expenses. Of course, under the current structure, there has also been the small matter of no proceeds to the company. What’s more, companies may be on their own when it comes to any marketing effort, otherwise typically provided by the bankers, and there may be only limited banker support of the stock price in the aftermarket. And what about that first day pop in the stock that can breed so much excitement?
Those that favor direct listings consider that first day pop to mean that the company has left too much on the table. They also complain about the rigid underwriting commission structure. And insiders are often especially pleased with direct listings because, unlike with underwritten IPOs, there is no “lockup period,” and shareholders are free to sell their shares right away.
For some companies that have taken advantage of the fertile territory for capital raising provided by the private markets—after all, that’s how they got to be unicorns—the limitation to secondary sales has not been a deterrent as they may have no need for additional capital at that point. Their motivation for becoming public may have more to do with shareholder liquidity and obtaining the “currency” that publicly traded stock can provide in the context of acquisitions and similar transactions. But that’s certainly not the case for most IPO companies, and the direct-listing limitation to secondary sales has put a definite crimp in the potential popularity of the direct listing alternative. Is all that about to end?
Since the splashy market debuts of two companies via direct listings, there has been a vociferous call from many VCs and others to revisit the well-trod path of the underwritten IPO as the only route to public-company status. According to Axios, there is “a growing investor consensus that the traditional VC-backed IPO process is antiquated and broken—too often benefiting…high-net-worth bank clients and a small pool of mutual and hedge funds, at the expense of issuers.” And just as some VCs are promoting direct listings as an IPO alternative, some of the major investment banks have held events and programs on direct listings to ensure that they are not persona non grata at the direct-listing party. (Or is it personae non gratae? The only Latin I know these days is quid pro quo.) According to Fortune, which spoke with four investment banks on the topic, although the investment banks say they “like direct listings,” not surprisingly, “they don’t think they’re a good option for every company.”
Whether or not the availability of primary direct listings completely upends the conventional underwritten route, many believe that the alternative process may encourage more companies to consider going public. Reuters cites an NYSE executive for that proposition: “Will this displace the traditional IPO? No, but is it another pathway we are providing companies to come to the public markets and to have investors participate and (have) growth opportunities? Yes.”
To that end, the NYSE proposal would amend Section 102.01B of the Listed Company Manual to permit a “Primary Direct Floor Listing,” which would “allow a company to sell shares on its own behalf in connection with its initial listing upon effectiveness of a registration statement, without a traditional underwritten public offering.” The company would sell its common shares in the opening auction on the first day of trading on the NYSE. The company could limit its offering to primary shares or, in its discretion, also include secondary shares.
The current rule for secondary direct listings requires the company to “demonstrate that it has $250 million in market value of publicly-held shares at the time of listing.” The proposal, however, would dispense with that requirement for a primary direct listing, so long as the company sold at least $250 million in shares in the opening auction on the first day of listing, as that would ensure a public market of at least $250 million after the first trade. For smaller primary offerings, the NYSE would require that the aggregate of the market value of publicly held shares immediately prior to listing and the market value of shares sold by the company in the opening auction be at least $250 million.
The proposal would also modify the distribution requirements in Section 102.01A of the Manual for listing in connection with both primary and secondary direct listings. Currently, a company is required to have at least 400 round lot holders and 1.1 million publicly held shares at the time of listing, which can be a challenge for a private company in a direct listing. Under the proposal, so long as the company sells at least $250 million in market value of shares in the opening auction on the initial listing date, it may commence trading and will have a 90-trading-day grace period to demonstrate compliance with the distribution requirements. The proposal would extend the same grace period for a secondary direct listing that demonstrates $350 million in market value of publicly held shares, and for a primary direct listing in which the aggregate of the market value of publicly held shares immediately prior to listing and the market value of shares sold by the company in the opening auction is at least $350 million. Any company that failed to meet the distribution standards within the grace period would not be compliant and would need to submit a compliance plan.