This article first appeared in Term Sheet, Fortune’s newsletter on deals and dealmakers. Sign up here.
Remember early 2017, when the IPO market looked bright and full of possibility?
The reality has been a bit… meh.
Two things could change that in the back half of the year: One, all companies can now benefit from the JOBS Act’s option to file in stealth mode, as Fortune’s Jeff John Roberts reported recently:
The stealth filing option, which is already available to firms with under $1 billion in revenue, is intended to let companies work out kinks in the registration process out of the public eye. … Under the new rules, they only have to do so 15 days before their so-called "roadshow"—a tour where they make presentations to investors.
The policy applies to both IPOs and direct listings, which brings me to my second point:
A successful direct listing from Spotify could prompt a wave of startups following the company’s footsteps. Direct listings – where a company starts selling its stock on the public markets without going through the whole roadshow song-and-dance process – are not new, but they’re extremely rare. I found a handful of examples: Ovascience (market cap: $55 million), Nexeon MedSystems, Coronado Biosciences, and BioLine Rx (market cap: $83 million). You’ve never heard of these companies because direct listings have been limited to small-cap companies, mostly in biotech and life sciences.
Spotify, last valued by private market investors at $8.5 billion, would likely be the first large company to go public via direct listing. In another first, Spotify is expected to list on NYSE, which recently changed its rules to accommodate for this exact transaction. Previously direct listings only happened on Nasdaq.
Companies undergoing direct listings file something called a Form 10. If they’re foreign, like Spotify, they file a Form 20-F.
As we’ve outlined before: There are plenty of benefits to this experiment. No investment bank. No new share issues, and no dilution. No lock-up period. No underwriters. (“If an IPO is like a wedding, a direct listing is running off to elope. A faster, easier, cheaper route to the same result.”)
And there are major risks: No deal support from the bankers. No guaranteed “safe” long hold investors. No greenshoe, and no buffer against volatility.
Anna Pinedo, a partner with the law firm Morrison & Forrester, has worked on several direct listings in the past. In her experience, there has never been more than a handful of direct listings in a given year. Thanks to the news of Spotify’s plans, she says more large companies have been inquiring about it. Given how quickly this could happen, I posed a few questions so we’re totally not caught off-guard some random morning when Spotify stock is suddenly trading on the free market.
Term Sheet: IPOs are designed to attract long-hold investors, the ideal kind of investors a company wants buying its stock. It’s easier for them to buy big chunks of stock all at once in an IPO. Less so in a direct listing, where limited shares will be for sale and pricing might be volatile. Will this make it harder for them to invest?
Anna Pinedo: In the past, maybe, but now so many of the unicorns and even the biotech companies have done these late stage private placements. [Public market investors] have gotten into those through their crossover funds that have invested already.
The part that’s most curious to me is, ‘How do you settle on that price at which you list?’ Usually in the process of doing an IPO, there is intense back and forth regarding the valuation model, discussions with research analysts and the investment banks underwriting it and will eventually cover the company. Is that process occurring already because a company has gotten so large that it’s having those discussions anyway?
What’s the reaction been like from the banking side?
People are just scratching their heads thinking, ‘Okay, I didn’t realize this was an approach.’ I’ve gotten a lot of questions about how does this functionally work, how would you go about doing this, why haven’t people done this before. It’s more the unknown and unfamiliar that has attracted everyone’s attention.
Is the preparation any different from a normal IPO?
It’s comparable. The 20-F or Form 10 is a pretty robust document, very much like a registration statement. It’s the same process you would go through with the accountant, but without doing a comfort letter, the IPO fees, probably not paying an underwriter, or going through the same kinds of drafting sessions and discussions about positioning the company or describing the company. It can be a process that the company controls a bit more than the IPO process, where it relinquishes some control to the underwriter and the working group as a whole.