Slack Is Going Public Without an IPO. Here’s How a Direct Listing Works

Ten years after it was founded, Slack Technologies will list its shares on the New York Stock Exchange on Thursday. The ticker symbol? WORK. And the NYSE has set Slack’s stock reference price, which may help determine where it starts trading, at $26 a share, valuing the company around $15.6 billion.

But in contrast to the vast majority of tech companies that go public using an initial public offering, or IPO, Slack will use a direct offering.

Slack’s workplace collaboration software is used by 600,000 companies and organizations, and is considered by many to be an indispensable alternative to older means of communications like email. For small investors anxious to own a piece of the company that plays a big role in their workdays, Slack’s stock debut presents an intriguing opportunity. Here’s how the direct offering will work.

Direct offering vs. initial public offering

Slack is going public through a direct public offering, also known as a direct listing. It’s a more obscure alternative to IPOs that few large companies considered before Spotify staged its direct offering in April 2018.

In an IPO, a company works with a group of underwriters, typically several Wall Street investment banks. Underwriting a financial asset guards against financial risk. (The term “underwriting” comes from the archaic practice of writing one’s name under the amount of risk taken on marine insurance policies.) In the case of a stock offering, underwriters agree to hold any shares they aren’t able to sell to investors through the offering.

Slack, like Spotify, is working with Goldman Sachs, Morgan Stanley, and Allen & Co. to list its shares directly on the NYSE, but not as underwriters.

Before an IPO, underwriters stage a roadshow with institutional investors to discuss a company’s financials and outlook. In the process, they assess demand and determine an initial price for the stock once it begins trading on an exchange. In contrast, direct offerings are priced by the stock market itself.

Before the stock begins trading, the stock exchange determines an “initial reference price.” Spotify’s reference price, for example, was $132.50 a share, at the high end of its trading range during the previous three months on private secondary markets. Slack’s reference price will be $26 a share, the NYSE said late Wednesday, which is right in the middle of its $21 a share-to-$31.50 a share range on private markets during the last three months, according to Slack’s S-1 registration statement.

Although a reference price may be the direct offering’s equivalent of an offering price, it’s different from the opening price of the stock. That will be determined Thursday morning by market makers who balance buy and sell orders at the start of the trading day. It can be a dicey proposition, but if managed right it can go smoothly.

Why go with a direct offering?

The key benefit of an IPO is to help a company raise money by selling new shares. In a direct offering, most existing shareholders are given the option to sell their shares directly into the stock market. These shareholders may include venture capital firms, employees who received stock as compensation, or accredited investors who bought shares in the private secondary markets. No new shares are offered.

In an IPO, SEC rules typically restrict shareholders from selling shares until six months after the offering. A direct offering makes it much easier for employees and early investors to cash out as soon as the first day of trading. This can be a big help for investors in companies that have waited to go public, which many of the best-known tech companies have been doing for years.

A direct offering also offers a few other benefits. It avoids underwriting fees, which generally run between 4% and 7% of the total proceeds raised in IPO. It obviates the lengthy roadshow, provided that most institutional investors are already familiar with the company. And it offers less risk of trading volatility. Underwriters often underprice IPOs to create the first-day “pop,” only to see the price slump after the six-month lock-up period expires and insiders sell shares.

Will direct offerings become more common?

Most companies heading for the public market will still work with underwriters on IPOs, but a select few may opt for direct listings. Airbnb is sometimes mentioned as a potential DPO candidate.

IPOs still offer benefits for companies, mainly the ability to raise new capital and to generate publicity and attention, not just to potential shareholders but to customers as well. Direct offerings can involve more risk—although that risk is lessened if a company doesn’t need to raise more cash, is a household name known to retail investors, and has a group of employees and investors clamoring to sell their shares in the stock market.

“The success of Spotify’s direct listing was due in part to Spotify being a well-capitalized company with no immediate need to raise additional capital, while also having a large and diverse shareholder base that could provide sufficient supply-side liquidity on the first day of trading, as well as a well-recognized brand name and an easily understood business model,” Latham & Watkins, a law firm that worked with Spotify on its offering, wrote in a subsequent case study. “Companies that do not share these traits may not be the right fit for a direct listing.”

The number of companies that pursue direct offerings may increase in coming years, but only slightly. IPOs will remain the main onramp to the stock market though Spotify’s direct listing set a template that seemed to work. If Slack’s offering goes smoothly, a few larger, well-known companies may follow its direct path into the public market.

For most small investors, Slack going public via a direct offering rather than an IPO won’t change much. There may be some initial volatility as the initial price is set, but Slack is still required to disclose its financial information as IPO candidates do. Still, having a handle on the process Slack is taking to go public is part of the due diligence that all investors need to perform.

More must-read stories from Fortune:

4 things investors need to know about Slack’s direct listing

—What, exactly, is Slack? And more FAQ.

—Slack’s CEO was raised in a log cabin—and now he’s worth $1.3 billion

—When the next recession hits, four good things could happen

—Listen to our new audio briefing, Fortune 500 Daily

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