Direct Listings: What the “Spotify Rule” Means for Startups

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IPOs are the end of the line. Traditionally, founders who pushed for an IPO were looking for either more capital to fund their operations or a fair market valuation of their business. A public offering opens the floodgates to new cash from institutional and retail investors, hopefully giving a blood infusion to a business that may have been relying on venture capital or private borrowing.

But now, companies listing on the NYSE are pushing for the ability to offer shares directly to the public, without going through the rigamarole of a traditional IPO.


Why not IPO?

In an IPO, one or more investment firms buy up the shares of a business and then offer those shares to the public. Usually, the firms offering the shares get those shares at a discount on top of the fees they charge for the underwriting service.

The listing bank would vette the business being listed, figure out an appropriate value for the stock, and then go on the road to present the business to potential investors. Those first IPO investors are usually institutional investors or massive traders.

So when a business has an IPO for $10, that price is really a reflection of what a few buyers are able to get by buying huge amounts of stock through an agreement with one of the banks. Often, banks and early investors will have a pecking order for who can buy shares at or close to that $10 mark.

The rest of us only get in on the action after that initial round. As a personal investor, you may be lucky to find that stock for less than $15. By the time it gets to you, seven other people may have owned it, even if you’re buying within the first hour of availability.

What is a direct listing?

Direct listings or direct public offerings (DPO) are a way to list a company on an exchange without going through a traditional IPO. In a direct listing, businesses offer shares of themselves directly to the market without working through a listing bank.

DPOs attempt to cut out the middlemen to decrease transaction costs for the listing business and to make the process more transparent. Well- established companies may already know how much they’re worth and the market may already know what they do.

Spotify, for instance, has already gone through eight funding rounds and has shares traded on some secondary markets. As of last year, the company was valued at somewhere between $8 billion and $10 billion.

If it doesn’t need to drum up support or hone in on a valuation, Spotify might want to skip out on the whole IPO circus and its associated costs.

To actually take on that kind of listing, a company could just head to the over-the-counter (OTC) market, where smaller, less popular stocks are traded. OTC stocks don’t work with an exchange and don’t have the same SEC filing requirements of exchange listed businesses.

OTC market pricing works on a less transparent system than the exchanges. Traders set the prices they want, with no real published price. You could buy a stock on the OTC for $100 and have a friend buy the exact same thing for $70 at the same time. It all depends on the trader you’re working with.

On the NYSE or NASDAQ, prices are published constantly, letting you know what the market is willing to bear for any given stock. While there is some price fluctuation at any moment, that discrepancy is transparent to the buyer and seller.

While NASDAQ allows direct public offerings due to an SEC exemption, the NYSE has no such exemption – yet.

Spotify on the NYSE

Spotify is reportedly shooting for an NYSE listing, but wants to use a more modern listing technique. It’s a sign that the company wants some of the prestige that comes with a NYSE listing but also wants the tech vibe that comes with a direct listing.

A DPO also signals that Spotify doesn’t need to raise more money. When a company IPOs, it’s often attempting to turn unrealized value into actual value. That means turning shares that have only ever had paper value into real, tradeable shares.

In Spotify’s DPO, it’s basically just opening the rest of the market up to the shares it’s already trading internally. It’s not uncommon for businesses to run their own internal markets, allowing employees or investors to buy and sell stock among themselves.

Implications for SMBs

Because it’s an established phenomenon, it may mean that some medium-sized businesses decide to take the leap to the market with a DPO. While it’s not as simple as just deciding to do so, tearing down a hurdle to an NYSE listing may be just what some start-ups need.

There are plenty of businesses on the NYSE with sub-$250 million market capitalizations. That’s a target many growing medium-sized businesses can realistically hit.

The difficulty for SMBs is that DPOs raise less capital, which is really what growing businesses need. By offering shares directly, you’re unlikely to see the cash influx you would see with a traditional IPO. That said, you will get some bounce, for less cash than an IPO would cost.

We’re not talking cheap, but we’re not talking about millions of dollars either.

If we move beyond traditional businesses and start looking at “startups,” things get more interesting. Now we’re looking at an alternative to a third funding round and a pressure release valve for investors.

An increase in the number of options – albeit a minor one, as the NASDAQ was already an option – could give startups more leverage in fundraising discussions. Venture capital is no longer the sole source of fund raising, which might result in better terms for businesses looking to negotiate deals.

The hazy future

We’ll know more about what DPOs coming to the NYSE – hope you like acronyms – means for businesses this time next year. It may be that Spotify balks at the last minute and decides to go down a traditional route, or not go public at all.

It may be that Spotify emboldens other businesses and the floodgates open. A lot of it will hinge on how smooth Spotify’s offering goes.

Even if it all goes according to plan, though, it doesn’t necessitate a change in behavior. Remember Google’s Dutch auction back in 2004? It went great and the company has continued to dominate the world. No one cares about Dutch auctions, though.

Google may have changed the world, but it failed to even budge the IPO process.

Let me know in the comments if you’ve ever dreamt of hitting the big time on the NYSE. Would being able to go it alone change how you thought about the process? As always, feel free to shoot me an email if you’d like to discuss anything here in more depth.

Good luck.

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About the Author


Andrew Marder

Andrew Marder is a former Capterra analyst.


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