The success of fintech Wise’s direct listing in the UK in July makes it certain that other companies will follow suit; however, while it has many benefits, a direct listing is no wholesale replacement for the traditional IPO.
As the UK grapples with its post-Brexit status, following a long period that has seen it lag in efforts to capture a decent share of the global initial public offering (IPO) market, many are wondering if the so-called ‘direct listing’ could provide an attractive alternative to the traditional IPO and attract more listings to London.
The short answer is ‘Yes’. The caveat is that it will not be for everyone.
A direct listing essentially involves a listing of a company’s shares without an equity raise. Historically, direct listings have been more popular in the US, with Spotify and Slack being high-profile examples.
The key difference between this and a traditional IPO is that there is no formal book-building process; instead the stock exchange holds an auction to investors. In theory, this allows for true market-based price discovery since, in the absence of lockups, all of an issuer’s shares are available for trading on day one.
This process opens up participation to a wider pool of investors, but the issuer has less control over its initial shareholder base since it cannot allocate shares to preferred investors. While this, arguably, levels the playing field for both institutional and retail investors, it could put off traditional long-term investors who are wary of a shareholder base with a sizeable short-term investor contingent.
The role of banks
This is hardly the end of the banks’ role in IPOs.
Clearly, the appeal of a direct listing from an issuer’s perspective is saving on expensive underwriter fees. However, before prospective issuers get too excited about sidelining the banks entirely, flying solo on an IPO is ill-advised.
Banks can offer advisory services in connection with deal execution, acting as a sponsor on a premium listing or acting as private placement adviser for any pre-IPO fundraising.
Banks can offer advisory services in connection with deal execution
While not as lucrative as underwriting fees, the banks clearly will not need to be split across a large underwriting syndicate. The quid pro quo is that there is no bank support on the tail end of the direct listing process, which an issuer would typically get in a traditional IPO.
By not conducting a book build, no price range will guide the market with respect to opening trades, which could lead to price volatility in the first days of trading. As stabilisation activities are not technically permitted, since there is no offering to stabilise, banks cannot smooth out price volatility through market purchases or support greater demand through exercising a so-called ‘greenshoe’ option, which provides for the sale of an extra block of shares. Instead, the exchange employs a price monitoring extension mechanism if the share price swings dramatically.
As no shares are being sold off the back of the prospectus and there is no underwriting of settlement risk, there is clearly less potential legal liability for the banks. However, issuers and their financial advisers should be careful if any pre-IPO fundraising involves an offering document in close proximity to the listing.
As one banker aptly put it: the direct listing route is like trying to sell your house without an estate agent. It is possible, but arguably more difficult.
Direct listing candidates
Although attractive at first blush due to lower costs and a simpler route to market, a direct listing will not suit all companies. Many companies file an IPO precisely to raise new capital, so a direct listing will not be a viable option, although, of course, they could raise cash privately before an IPO.
Moreover, one of the biggest hurdles for a direct listing is satisfying the free float requirements. Few IPO candidates will have a broad enough shareholder base to meet the 25% threshold (50% for FTSE index inclusion for non-UK issuers) without a public offering — particularly 100% private equity-owned businesses — but it could mean that forward-thinking companies will consider building their registers early on so that they can incorporate a direct listing as part of their exit strategy. In any event, free float requirements will likely change following Lord Hill’s recommendations.
Finally, ideal direct listing candidates will have a well-known brand and straightforward equity story that can attract day-one support for the stock.
Another route to market
Following fintech Wise’s successful direct listing in July, it is certain other companies will follow suit; however, while it has many benefits, a direct listing is no wholesale replacement for the traditional IPO — it simply represents another route to market.
Direct listings arguably favour technology companies who are the flavour du jour and have particularly attractive equity stories but, over time, the appeal of direct listings may broaden. We may also see direct listings becoming a viable option for companies seeking to list during economic downturns to avoid building order books in a difficult market, while enabling them to be ready to tap capital quickly once conditions improve.
With the burgeoning trends of special purpose acquisition companies and direct listings, one thing is for sure: London is clearly open to innovative routes to market, and could be a natural home for technology and early growth companies looking to list.
Ariel White-Tsimikalis is a partner at law firm Bryan Cave Leighton Paisner.
