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IPO vs. Direct Listing: difference and drawbacks. Benefits of Direct listing during raising capital.

You can get competitive edge not only with innovations in product but also in how you raise capital. Learn such innovations in this article.
8 APRIL, 2021
Capital Raising
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Long ago everybody went to the stock market the classical way, via an IPO. Then, everything changed when Slack and Spotify gave preference to a direct listing.

And the change was quite significant. The two biggest exchanges, the London Stock Exchange and the NYSE, submitted requests to regulators to let them use direct listing for attracting capital. And the American exchange has already received approval.

Replacements to IPO became very popular in recent years. Direct listing, SPACs, STOs. In one of the previous videos, we discussed a security token offering as an unknown but compelling alternative that reduces cost more than tenfold. In this article, I will tell you about a more popular unconventional option – direct listing – and discuss whether it is actually better than doing an initial public offering.

What's the Difference between IPO and Direct Listing?

Firstly, we need to understand the classical initial public offering process. Generally, it has the following flow.
After deciding to do an IPO, you go to investment bankers, such as Goldman Sachs, JP Morgan, or Barclays. They start the preparation process, conduct due diligence, evaluate your financial statements and market situation to determine your shares' price range.
Then they organize a roadshow – gather a bunch of large institutional investors and allow you to present your company to them to estimate the demand and get feedback on whether they got your price right.

At the end of the roadshow, your IB advisors determine the final price for your securities– and then underwrite them. Underwriting is when the Investment Bank purchases your shares at a fixed price you negotiated and then sells them to institutional investors at a price they negotiate, which may be higher and lower. Institutional investors trade among themselves and, eventually, sell to the public in a stock exchange.
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IPO is a very traditional process with a history of hundreds of years. Like all old things, it is poised for disruption, which is becoming more visible with new forms of fundraising being introduced targeted at different firm sizes: direct listing and SPACs for larger firms, ICO, STO, equity crowdfunding for small businesses. Direct listing is the most similar option to the initial public offering. Unlike a security token offering, it does not displace all the intermediaries: exchanges, custodians, brokers, only the most expensive ones – investment bankers.

Learn more about a direct listing and investment crowdfunding alternative.

Benefits and Drawbacks of a Direct Listing

The classical IPO procedure has a very long chain of intermediaries. The main idea of the direct listing is to cut this long chain of intermediaries. Instead of selling securities to underwriters who then resell them to institutional investors, businesses that choose this method come right to the stock exchange and make their securities available to be traded.

Recently companies couldn't sell new stocks by undergoing a direct listing, only to make existing ones traded. This means that early stockholders, employees, and founders didn't have an opportunity to trade their shares on the secondary market; however, the company could not raise capital by issuing and selling new shares. However, after the US regulator gave the green light to attracting money via the direct listing on the NYSE, this is about to change and this alternative option is going to become a more prominent replacement for a conventional IPO.

Why Do Companies Choose Direct Listing?

Now when we know all pros and cons, we need to answer whether a direct listing is really a better alternative to choose. The major points of comparison are cost and risk.

The main implication of the cumbersome initial public offering procedure is an extremely high cost. Conducting an IPO costs tens or sometimes even hundreds of millions of dollars, and expenses on underwriting constitute from 50% to 85% of total IPO expenses. Even though companies undergoing direct placement cannot cut off all of these expenses because they still need a financial advisor to determine the price of their securities, there is already no need to pay bankers for organizing roadshows and taking part in the risk related to the fundraising process, which allows reducing expenses quite significantly. Moreover, for simpler financial advisory you don’t need top-level investment bankers, which was not the case for building relationships with institutions.

Oppositely, direct public offering adds additional marketing costs to ensure that investors are aware of the IPO and want to take part. The amount spent on marketing is proportional to the funds raised. As there haven’t been fundraising cases by this kind of placement, it’s hard to say what the proportion is going to be. For IPOs, the cost is 5-10% of expected proceeds. Given that marketing of the fundraising is also marketing of the company and its brand and vice versa, it is plausible that the numbers will be better.

The drawback of the direct listing as a fundraising tool is the lack of guarantee. In the traditional procedure, banks buy the securities from you at a fixed price, and then you don’t care if they make any profit from it or not. While in the case of the direct listing you go directly to the market and it is not guaranteed. On the other hand, the question is whether you need a guarantee. If the business becomes publicly traded, it is likely to already have decent recognition, and it is still going to hire financial advisors to define the cost.

This is an excellent chance for companies like Slack and Spotify, and more generally, businesses with a strong consumer brand and recognition. Ten years ago, the markets were ruled by sophisticated institutional investors, so you needed investment bankers who could get your finances right and leverage their relationships with investors. However, with the rise of Robinhood and commission-free brokerages, the power shifted to Main Street, so now a compelling story and brand recognition have a more substantial impact on the cost of capital than economic fundamentals.

Not all companies need to become publicly traded, so it may be hard to decide how to raise capital for your business. Therefore, we strive to introduce you to various possible options and help you make an informed decision. Learn more during a free STO consultation call with a Stobox expert.
Consulting for Security Token Offerings (STO)
We offer advisory, legal expertise and software solution to help successfully execute a security token offering.

At Stobox, we provide clients with a great alternative to the traditional methods – Security Token Offering – which allows not only saving money but also increasing brand recognition and customer loyalty. If you would like to find out whether tokenization as a type of raising capital would suit your kind of business, subscribe for free digital assets consulting with our professionals here.
Watch our video on “Why Slack and Spotify chose Direct listing over IPO: stock market explained”, share your feedback in the comments section, and subscribe to our channel to stay updated about the modern ways of fundraising.

8 APRIL, 2021
Capital Raising
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