Direct Listings on NYSE Approved by SEC as IPO Alternative
IPOs have been all the rage in 2020. At the end of December, the Securities and Exchange Commission (SEC) approved a rule that the New York Stock Exchange (NYSE) proposed. The new rule allows companies to raise new capital through direct listings, an alternative to traditional IPOs. The NYSE plan could help startups more easily access the capital markets by lowering bank fees and other regulatory barriers to going public.
New Capital Can Be Raised via Direct Listings
Previously, direct listings were available only for companies to sell existing shares, not to raise new capital. A handful of tech companies with cash heavy balance sheets, such as Palantir, Spotify, and Slack, have used direct listings in recent years. Founders and early investors could cash out on existing shares amid strong market conditions. Under this new NYSE rule, companies will be able to sell new shares to public investors on the first day of trading in a single transaction.
An influential trade group, the Council of Institutional Investors, set forth arguments strongly rejecting the NYSE’s proposal. The main focus of their arguments was that it would erode essential investor protections provided by the traditional IPO process. They argued that underwriters act as gatekeepers to help prevent mismanaged or fraudulent companies from going public, and cutting out these middlemen from the process could be perilous. Despite the trade group’s efforts to block the NYSE direct listings plan, the SEC approved the new type of direct listing process. In its approval order, the SEC asserted that the NYSE plan is consistent with the protection of investors.
Game Changer for Capital Markets
“This is a game changer for our capital markets, leveling the playing field for everyday investors and providing companies with another path to go public,” states Stacey Cunningham, President of the NYSE. “The banks are still providing services to companies when they choose to do direct listings, and they get compensated for providing that value to them when they’re working with them.” Cunningham opined that enabling new money to be raised through a direct listing process will encourage participation from both retail and institutional investors alike and therefore better reflect market demand.
The SEC further commented on the approved NYSE plan in an order posted on its website: “The Commission finds that the New York Stock Exchange’s proposal will facilitate the orderly distribution and trading of shares, as well as foster competition.”
Directs Listings Less Expensive Than IPOs
Traditional IPOs require paying expensive fees to investment banks that act as underwriters. Underwriters help sell the securities to other institutional investors, perform diligence, and buy securities from the issuer. Underwriter fees are a huge barrier for startups that often lack sufficient funds to cover the hefty fees. Cutting out the Wall Street bank intermediaries that typically underwrite capital raises will be a game changer for many companies.
Bill Gurley, a general partner at venture capital firm Benchmark, speculates that the SEC’s approval of the new type of direct listing will “unquestionably” lead to the end of traditional IPOs. Long critical of the traditional IPO process, Gurley contended, “I can’t imagine, when you can do a primary offering through a direct listing, why any board or CEO or founder would choose to go through this archaic process that has resulted in massive one-day wealth transfers straight from founders, employees, and investors to the buy side.”
Most companies go public in order to raise new capital. The NYSE plan is likely to make direct listings more common. In a traditional IPO, investment banks often purposely underprice IPOs so that the stock price will pop once listed on the public market. This delivers huge gains for institutional investors such as the mutual funds or hedge funds that bought shares in the company before the IPO. The NYSE’s new type of direct listing opens the door to all investors. However, this could also mean more volatility in the stock prices of companies that elect to use a direct listing over a traditional IPO. If there is robust public demand for the company’s stock, more money could potentially be raised. In contrast, lackluster public demand could result in steeper price declines.
Direct Listings Allow A Streamlined Process
The NYSE, owned by Intercontinental Exchange, proposed its idea for a streamlined direct listing process to the SEC over a year ago. NASDAQ, the main rival stock exchange to the NYSE in the United States, has submitted a similar direct listing plan to the SEC. It is still awaiting approval. Although the recently approved NYSE plan and the proposed NASDAQ plan are quite similar, there are some distinctions. Most notably, the NASDAQ rule would only apply to direct listings on NASDAQ’s highest tier—the Global Select Market. NASDAQ has three distinct tiers—the NASDAQ Global Select Market, the NASDAQ Global Market, and the NASDAQ Capital Market. The Global Select Market tier.requires certain liquidity, corporate governance, and financial benchmarks. The market value requirement for the Global Select Market tier is at least $110 million of unrestricted publicly held stock.