The difference between an Initial Public Offering and a Direct Listing

Private companies decide to go public for diverse reasons. Some are looking for capital to pay off debt, or to invest in expansion or research, while others simply want to increase public awareness of their brand.

To fill these needs, they can choose from an initial public offering, selling stock to generate capital, or to pursue a direct listing that only sells existing shares. Each has its own advantages and disadvantages. Let’s look at the differences between the two.

Going through an initial public offering represents a significant commitment of time and money. In order to issue and offer new shares to the public, an organization needs to engage underwriting services, usually from investment banks that charge between 2% and 8% of the capital raised in exchange for their services. In exchange, they advise on share price, file all appropriate paperwork with the SEC, and coordinate the official introduction to the public market that is known as the “roadshow.” During the roadshow the company’s executives accompany the underwriters on travels to institutional investors, talking up the company’s potential in order to generate interest and establish a final price for the IPO.

The regulatory requirements of an IPO are rigorous and the process itself is extremely time consuming. It can take months between the beginning of an IPO project and the actual sale of shares to institutional investors, mutual funds and others.

Though an IPO is a good deal of work and can be expensive, it offers several benefits. The company’s shares are presented to a much larger pool of potential investors, and the underwriters offer real value-added benefits in the form of promotion and exposure. By the same token, selling additional shares dilutes ownership in the company, and the underwriters have the power to sell even more shares than originally agreed upon if they have a “greenshoe option” available, which allows them to do so in response to demand. 

When a company decides to go public via a direct listing, there are no new shares of stock offered and no capital raised. The process involves making privately held shares available to the public. These are usually owned by early investors and employees of the company. Not only does selling these shares provide those earliest shareholders with the ability to get their money out of the business, it accomplishes the goal of taking the company public quickly and with far fewer regulatory requirements. It eliminates the fees, additional expense and effort involved in using underwriters and participating in a roadshow.

For companies that have successfully raised capital on their own or that can’t afford or are unwilling to pay hefty underwriting fees, a direct listing offers a choice that is both efficient and effective. Not only are they able to maintain control of the number of their shares on the street, they also have the added benefit of allowing their existing shareholders to sell their shares whenever they want instead of being limited by the 180 day lockup period that is required of investors and employees selling shares after an IPO.

Though direct listings were once a rarity, they have become far more common, and many entrepreneurs see it as an excellent way to bring attention to their companies while providing liquidity for those who invested in them early.