Two lead executives on Spotify Technology’s groundbreaking direct listing three years ago are expecting momentum in the asset class to continue as a more transparent alternative to traditional initial public offerings.
The Nasdaq is also working on rule changes that could potentially make direct listings more attractive for companies to sell shares along with their stockholders. For now, companies simply register shares for insiders and other investors to trade on an opening day — not unlike the opening of any stock — and don’t keep the proceeds.
That’s how online data management company Amplitude
and eyeglass retailer Warby Parker
went public on Tuesday and Wednesday this week. It’s the first time two direct listings have taken place in a single week, following about a dozen direct listings since Spotify’s inaugural deal in 2018.
Amplitude CEO Spenser Skates told MarketWatch that traditional IPOs are “antiquated” and said companies who go that route often end up underpricing their shares.
Barry McCarthy, retired CFO of Spotify
and former CFO of Netflix
and Greg Rodgers, the partner at Latham & Watkins who both worked on the first direct listing by Spotify in 2018, see ample opportunities for more direct listings.
“‘Direct listing was not a new idea. It had been around for a long time and was mostly used by companies coming out of bankruptcy proceeding and for corporate spinouts. What was ‘new’ was the idea of using a direct listing in place of an IPO.’”
— Barry McCarthy, ex-CFO, Spotify
“Although so far we’ve only seen tech companies use the direct listing, we’ve had a lot of interest from other industries and in our view it is only a matter of time before it is more widely adopted,” Rodgers told MarketWatch. “We view it as just another option to going public. It’s a great fit for the right company.”
Along with Spotify, Warby Parker and Amplitude, other companies to go public through a direct listing include Slack, now owned by Salesforce.com Inc.
and Watford Holdings in 2019, Asana
and Thryv Holdings
in 2020, followed by Roblox
“Direct listing was not a new idea,” McCarthy said in an email. “It had been around for a long time and was mostly used by companies coming out of bankruptcy proceeding and for corporate spinouts. What was ‘new’ was the idea of using a direct listing in place of an IPO.”
In a recent twist that has yet to be executed by a direct listing company, stock exchange rules at the NYSE and the Nasdaq have been introduced to allow companies to also sell shares in the direct listing and raise dollar proceeds in the first trade.
One reason no issuers have done this, yet, is because of existing rules that require direct listing shares to trade within a fixed range of the reference price published in the company’s stock prospectus.
A proposed rule change by the Nasdaq will no longer require shares sold by a company to trade in a range. The move may make it more appealing for companies to raise capital in a direct listing. The Nasdaq has published a draft of the rules and is weighing comments on them. A spokesperson from the Nasdaq declined to provide additional comment.
The pricing rule changes by Nasdaq represent “constructive progress” to evolve direct listings, McCarthy said. “Without these changes, selling shares in a direct offering by a company would have been dead on arrival,” he said.
Latham & Watkins partner Rodgers said these proposed company stock sales will likely be much smaller than traditional IPOs for a couple of reasons. A smaller share sale in a direct listing reduces the risk of selling at a low market price on the opening day, he said. A large number of fresh company shares in a direct offering may dilute prices by increasing the supply of stock, and companies may want to avoid this by doing smaller stock sales, he said.
For bigger capital raises, companies may still be better served by a traditional IPO.
The genesis and future of direct listings
For his part, McCarthy has not walked back from past comments on the shortcomings of traditional IPOs. In 2019, he told Inc. magazine that it’s “moronic” that the IPO process has remained static for so long.
The narrative of bankers deciding IPO prices and doling out shares to their richest clients in smoke-filled rooms has dogged the asset class for decades. Company executives and other insiders who hold pre-IPO shares also bristle at selling shares to underwriters at one price, and then seeing their stock jump to a much higher value once it starts trading. Holders of pre-IPO shares face share lockup restrictions that prevent the sale of their stock for months after an IPO.
McCarthy started developing the idea for direct listings around 2017-2018 as a way to go public without the sale of shares to underwriters. In other words, he wanted to drop the “O” in IPO because Spotify didn’t need capital from an IPO because of strong support from private investors. Insiders who owned pre-IPO shares wanted to sell their stock at a more transparent market price, not an IPO price set by underwriters through an opaque process.
“‘The narrative of bankers deciding IPO prices and doling out shares to their richest clients in smoke-filled rooms has dogged the asset class for decades. Company executives and other insiders who hold pre-IPO shares also bristle at selling shares to underwriters at one price, and then seeing their stock jump to a much higher value once it starts trading.’”
By that time, Spotify was already several times larger than Netflix was when McCarthy took the video streaming company public as CFO in 2010. Spotify had more than three times the subscriptions, more than double the revenue and about 10 times the cash of Netflix at that point. McCarthy figured Spotify would be too big to ignore if it tried something new.
“I began to think that given the scale of the business, we had an opportunity to create our own ecosystem,” McCarthy said. “I also had a founder [Daniel Ek] who was excited about doing something groundbreaking.”
Spotify turned to Latham & Watkins partly because of its track record in dealing with the Securities and Exchange Commission and its experience in getting overseas companies listed since Spotify is based in Stockholm, he said.
The Latham & Watkins roster on Spotify’s direct listing included partners Marc Jaffe, Benjamin Cohen, Dana Fleischman (now retired), Alex Cohen and Paul Dudek, with Rodgers acting as quarterback for the team.
Rodgers said the SEC was looking for ways to increase the number of public companies and viewed another viable means of going public as a good thing. But the process was still challenging given it had not been done before.
“The essential problem we had was that even though we thought this was a simplification, the entire history and jurisprudence around securities offerings were centered on underwritten offerings,” Rodgers said. “We were staring at rules that didn’t work.”
The regulatory process for the direct listing was much more in depth than a typical IPO and it took roughly a year, but the deal got done.
“After the success of Spotify, we hit the road to educate our clients about the innovative structure,” Rodgers said.
After about a year, Slack opted for a direct listing and went public successfully. Unlike Europe-based Spotify, Slack was more of a traditional Silicon Valley-based, venture-backed company.
“Slack was the one that made the venture capital community in California take notice,” Rodgers said. Bill Gurley, general partner at venture capital firm Benchmark, has been an advocate of direct listings, for example. Gurley did not reply to an email.
““A belief in direct listing requires a belief in markets. The truest price will be achieved by the largest number of buyers engaging with the largest number of sellers. And the outcome is your true price. At the end of the day, Barry [and other Spotify executives and investors] wanted the stock price to be set with as few artificial constraints as possible.””
— GregRodgers, partner, Latham & Watkins
Latham also advised on the direct listing of Wise, the first direct listing of a technology company on the London Stock Exchange.
After Slack, the pace of direct listings increased, particularly in 2021.
While some companies will still need to do traditional IPOs to raise larger amounts of capital, more mature companies with many private shareholders may opt for direct listings to allow insiders to sell their stock in the open market without the additional steps of an IPO, such as the roadshow and underwriters setting the price.
“A belief in direct listing requires a belief in markets,” Rodgers said. “The truest price will be achieved by the largest number of buyers engaging with the largest number of sellers. And the outcome is your true price. At the end of the day, Barry [and other Spotify executives and investors] wanted the stock price to be set with as few artificial constraints as possible.”