First Spotify changed the music industry. Now it might change the way we think about public offerings.
On Wednesday, February 28, 2018, Spotify filed its prospectus to go public through a direct listing on the New York Stock Exchange (NYSE). In a direct listing, a company puts its shares on a stock exchange without first raising additional funds or offering additional shares. In doing so, the company bypasses costs associated with an underwriter and avoids the formal roadshow, testing the water discussions, and other time-consuming and costly processes associated with traditional IPOs. It also does not have the traditional 180 day contractual lockup period customarily associated with an IPO. Companies must file a registration statement with the Securities and Exchange Commission (SEC) and are still subject to SEC reporting and compliance requirements after conducting a direct listing.
While the direct listing method had previously been available to companies on NASDAQ and also NYSE under certain circumstances, in early February the SEC approved amendments to the NYSE rules which modify its listing standards in order to facilitate direct listings. Under the new NYSE rules for direct listings, a company must prove that the market value of its publicly-held shares is $100 million in the aggregate. This market value must be evidenced by a third party valuation and the most recent trading price for the company’s common stock in a private market. If the third party valuation judges the publicly-held shares to be worth $250 million aggregate, no evidence of a private market price is necessary.
Direct listings have risks associated with them, which is likely why they have not been favored by companies in the past. By not hiring an underwriter to drum up support for the stock before it goes public, the pricing of the stock on the first day of the offering could be volatile. If many stockholders choose to sell off their holdings, the price of the stock could sink, while if too few stockholders sell, the market may struggle to gauge a price for the shares. Additionally, there is no guarantee of the robust aftermarket for trading that an underwriter often creates in the case of an IPO or the promise of a greenshoe to act as a stabilizer should the stock stumble out of the gate.
Spotify will be a test in how a larger company can weather these risks. The company’s large shareholder base, robust financial posture and brand recognition could put it in a position to overcome the challenges associated with a direct listing and lead to a successful offering.
Should other companies follow Spotify’s lead?
In addition to reducing costs and avoiding a lock-up period, a direct listing can have positive effects for recruitment and retention of employees and supporters. It presents a liquidity opportunity for employees and others holding shares without diluting said shares’ value through the issuance of more stock, as happens in an IPO. For companies hoping to increase their assets through acquisitions, a class of shares listed on an exchange can also serve as acquisition currency. There are clearly benefits to having a successful direct listing, but the key is whether a company has sufficient interest from investors and a firm grasp on the value of their shares without the help of an underwriter.