During an IPO boom, fast-growing companies typically go public for one reason alone: to raise cash. Lyft, Pinterest, and Zoom are just a few of the closely watched startups to debut in recent months, raising billions in the public markets to fuel their growth.
But now there’s a new twist: Going public without raising any funds at all.
Messaging giant Slack filed for a so-called direct listing last week. It’s a considerably cheaper method of going public in which only existing shares are sold, no cash is raised for the company, and bank underwriters that help market the deal are cut out. But to have chance at successfully executing a direct listing, companies have to clear a higher bar. They must be willing to say that they don’t need more cash, don’t need to fine-tune marketing, and are still worth buying. And there aren’t many candidates that fit in that pool. “When you boil it down, the true population of companies that can manage a direct listing is really small—Maybe 10,” says Deloitte & Touche Partner, Barrett Daniels.
Slack is following a small group of other companies that have chosen this route. The only large scale one being Spotify, which did a direct listing last year. And though it used to be considered only a method utilized by smaller firms, $35 billion Airbnb is also reportedly considering a direct listing later this year. The deals come amid a surge in private funding that has kept some aging, cash-burning giants well capitalized—but kept their investors and early employees locked into their paper wealth. Now as markets breach new highs, some are seeking cash for stock.
And in a time when Silicon Valley startups run on a “fail fast” directive, companies that aren’t desperate for cash are rare. But in 2018, Slack reported cash of roughly $841 million, allowing it to last for another 8.6 years at its current cash burn rate (an eon, in today’s Silicon Valley). It’s revenue is also in relatively good shape, growing at about 82% in 2018 while losses narrowed. Similarly, Spotify was not desperate for cash: it was cash flow positive at its direct listing. (That’s a huge contrast to companies like Uber and Lyft, which are growing fast but have less time to make their visions work without a fundraise.)
“Direct listing firms are only ones that are either not losing money or have tremendous growth,” says Elliot Lutzker, corporate and securities partner at Davidoff Hutcher & Citron. It also helps to already be “hot” name brand in the absence of underwriters—giving companies reasonable expectancy that they will have a ready field of buyers in the public sphere, says Daniels. In the case of Spotify’s IPO, the Securities and Exchange Commission sought assurance that the bank advisors involved in the deal weren’t acting as underwriters, and seeking to sell shares to clients. The typical one-week plus roadshow meanwhile, was relegated largely to a single day.
The rise of mega direct listings though could be a sign that more companies are getting creative when it comes to offering their shares in the future, says Eric Jensen of Cooley LLP. In a January conversation with TechCrunch, Spotify’s Chief Financial Officer said if the music streaming firm were to seek more financing, it would do so through a follow-on direct offering that would achieve better effects at a lower cost for the company. Indeed, there’s long been a tug of war between startups and Wall Street over the pricing of an IPO, making it a space ripe for disruption. “It’s an art, not a science,” says Jensen.
And it is certainly not lost on startups that by going public via IPO, they cede plenty to Wall Street. Underwriting fees for firms raising under $150 million generally run 7% of an offering, says Professor Jay Ritter of the University of Florida. Then, the banks tend to allocate shares of an IPO to their “most profitable clients,” says Ritter. “This allocation discretion incentivizes hedge funds and mutual funds to overpay on commissions on other transactions, such as paying 5 cents per share rather than 0.5 cents per share. The excess commissions are known as soft dollars, and are a big source of profits to investment banks,” he said. Underwriters market new shares to institutional investors with prices that are lower than what they would be priced on public markets—hence the famous and divisive first day IPO “pop.” While Wall Street may argue the difference between the offering price and the first day closing value will bring in more institutional investors, companies now going public could argue that it leaves capital on the table.
No doubt plenty of other startups will be watching Slack’s offering to if the direct route really is the optimal one.
