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STATE OF PLAY

A complete guide to the future of the IPO

Illustration of women being held up by a chart with confetti surrounding her.
Illustration by Antonio Sortino
By John Detrixhe
Published Last updated

Table of contents

  1. Breaking open the IPO
  2. Looking inside the black box
  3. Alternatives to an IPO
  4. The competition for global champions
  5. The future of China’s IPO market
  6. What’s next for SPACs
  7. Empowering a new wave of founders
  8. Rise of the retail investor
  9. Reading list

Breaking open the IPO

The first time Max Levchin was at the helm of a public listing was when PayPal put its shares on the Nasdaq exchange. It was 2002, and the PayPal co-founder remembers being on a flight over Boston during a thunderstorm. He was due to pitch his company for the 25th or so time, but his plane couldn’t get clearance to land, and he had to do everything possible to hold himself back from vomiting as the flight circled over Massachusetts.

By contrast, Affirm’s listing on Nasdaq in January never made him want to throw up. In typical Covid-19 pandemic fashion, Levchin spoke with investors by Zoom. He was barefoot and wearing shorts during the entire offering process. “There’s a lot of benefit in being able to do it from your desk, without having to get into a plane and hop around,” he said. “The industry of taking companies public has really evolved over the last two decades.”

The IPO is a critical cog in the global financial system, with roots that go back to 17th century Amsterdam where the Dutch East India company sold its shares to the public. And from the way some people talk about the process, sometimes you would think not much had changed over the past 400 years.

Detractors of IPOs in the US, which has the world’s deepest and most liquid capital markets (though China now has more IPOs), say the process is expensive and slow. And the naysayers have a point: A public offering can take a year or more, during which management not only undergoes an intensive back and forth with regulators to file a prospectus, but then embarks, traditionally, on a grueling cross-country “road show” to meet investors. Investment banks collect as much as 7% of the funds that are raised, while auditors and law firms can expect to pocket millions of dollars in fees. White men are far and away the biggest beneficiaries of American IPOs.

And then there’s the process of deciding who should get shares and how much those shares should cost. More than a few executives have called it a “black box” constructed by investment banks that benefits Wall Street and its clients at the companies’ expense. “The process of allocating and pricing is still a little bit of a black art where it’s a complicated conversation with smart people,” Levchin said. “That’s probably never going to change.”

So why do it? Mainly it’s because the public market is where the big money is.

  • It can be the only way for the founders of the most valuable companies to cash in on their hard work. Selling a billion-dollar startup to another company might not be an option if its competitors are too small to afford it. But the $45 trillion US stock market can absorb big companies without a hiccup.
  • Public companies can use their shares as a form of currency to buy competitors.
  • And while being public is cumbersome and expensive, it’s also rigorous. If all goes well, you end up with an enterprise with strong processes that make for a well run company.
  • The sheer number of buyers and sellers coming together in real time makes it the best place to figure out what a company is really worth.

All of which may partly explain why the IPO has been so fiendishly difficult to disrupt.

But while public listings aren’t being reinvented, they are changing. Quartz interviewed executives, investment bankers, academics, consultants, investors, and pored through numbers to get a glimpse of the future: The “black box” for deciding who gets shares, and at what price, is slowly being cracked open. The traditional IPO is here to stay, but management will have more control, more options, and will spend less time eating airline food than they used to. There is sustained pressure to open up funding to women and non-white entrepreneurs, which could help them build listed companies and in turn narrow the wealth gap. The US remains the global center for public listings, which is forcing other flagship exchanges around the world to become more like New York’s.

The new IPO market is a lot like the old one, but it’s gradually, sometimes kicking and screaming, being hauled into a new era.

Looking inside the black box

The short version: Startup founders and executive management are taking more control over decisions about who gets IPO shares. 

Startup founders like Levchin have a long-running quandary: They want big, patient investors to buy their stock, in hopes that these funds will keep the shares even when markets get choppy. Affirm’s CEO says one of the things he appreciated about meeting so many investors via Zoom was that it yielded a list of thoughtful money managers he wanted on his side. “I met a bunch that I thought, ‘Wow, I would be lucky to have these people as shareholders,'” he said.

Startup founders also want to sell their shares in the IPO at the highest possible price, enabling them to make as much money as they can when they cash in. Big-time investors, meanwhile, have sway and may expect to get shares at a discount. And Silicon Valley entrepreneurs have long complained that investment banks make it even worse, by rewarding their favorite clients with sweetheart deals at the issuing company’s expense.

The black box—who gets shares and at what price—has traditionally been controlled by Wall Street, but corporate executives have started to pick the lock.

Stocks that debuted last year jumped an average of 42% on their first day of trading, a level not seen since the dot-com mania at the turn of the century, according to data compiled by University of Florida professor Jay Ritter. That amounted to about $30 billion left on the table—quadruple that of the year before. Arguably, the alternative forms of equity listings that have made financial headlines lately—special purpose acquisition companies (SPACs), direct listings, hybrid auctions—are a response to the soaring first-day pop and a desire to price shares more efficiently.

Alternatives to an IPO

The short version: Between SPACs, direct listings, and auctions, management has more options than ever.

A SPAC gives management a chance to negotiate a price directly with its merger target, and investors can walk away and get their money back if they don’t like the deal. A direct listing skips the roadshow meetings between management and investors; the stock price gets set during the opening auction on an exchange, similarly to how stocks start trading each day. Some companies still do a traditional IPO but set the price in an auction. For example, Unity Software used a hybrid auction to gauge demand from investors. Then, instead of investment banks allocating the stock to investors, Unity’s execs made up their own mind.

So how’s it going? Some recent stocks priced in an auction have soared on the first day of trading, showing that cracking open the order book doesn’t necessarily get rid of a first-day stock jump. (Unity’s CFO has pondered whether they allocated so many shares to long-term holders that there wasn’t much trading supply on the first day, which pushed up prices.) Direct listings, by contrast, have been more muted on the first day of trading.

That doesn’t necessarily mean direct listings are the way to go—it’s still a small sample, and most experts think direct listings are likely to remain a niche service. “The reality is direct listings are only really, truly available for certain types of companies—companies with a high level of brand recognition, certain types of industries,” said Melody Koh, a partner at NextView Ventures.

Likewise, academics aren’t giving up on auctions, even after those of Unity Software and Airbnb blasted into stratosphere. Auction IPOs have provided average first day returns of about 12.5%, according to Ritters’ calculations based on two decades of data.

Direct listings, auctions, and SPACS aren’t revolutionary on their own, but they are giving companies leverage to see inside the process of allocating shares and are putting pressure on Wall Street fees.

“The tech community, they’re not shy about telling Wall Street that they’re charging too much,” said Chester Spatt, professor of finance at Carnegie Mellon University’s Tepper School of Business and former chief economist for the US Securities and Exchange Commission. “There might be a number of different techniques they use to get that message across.”

The competition for global champions

The short version: The world’s flagship exchanges are picking up tricks from New York’s.

Makram Azar was a senior banker at Barclays, the UK investment bank, and has worked on more than 200 deals during his career. But when he decided to raise funds to invest in a European technology company, he went to New York Stock Exchange to do it.

These days Azar is CEO of Golden Falcon Acquisition Corp—a $345 million pot of money, technically known as a Special Purpose Acquisition Company, seeking to merge with technology and fintech targets potentially based in Europe. Xavier Rolet, a Frenchman who used to run London Stock Exchange Group, is one of the directors.

“NYSE is the obvious primary venue for landmark brand names and companies such as the ones we are targeting,” Azar said. He ticked off a range of reasons for big companies with a worldwide footprint to list in the US: deeper capital markets, sophisticated investors who understand growing technology companies, a large bench of research analysts, and more “comps”—or similar companies that can be used for comparison to value a stock.

 

Not every company will list in the US, of course. Going public is rigorous and expensive, and American investors and analysts won’t have special insight into non-US companies that don’t have a multinational remit.

“For a global champion that happens to be headquartered in Europe but also has an international presence, including in the US—or an ambition to expand into the US—it makes more sense to list in New York,” said Azar.

That said, exchanges in the world’s big financial centers are gradually sanding off the differences between themselves and NYSE and Nasdaq. The exchanges have little choice but to become more homogenous. Otherwise they risk losing their most promising companies to an exchange in New York.

A few examples: Hong Kong’s exchange, after resisting the move, is allowing some companies to list with dual-class shares—the controversial setup used by companies like Facebook that can give founders extra voting rights and control relative to the amount of the company they actually own. London Stock Exchange is considering doing the same, and executives and officials in the UK capital are weighing whether to make it easier to form special purpose acquisition companies—the financial maneuver that’s become the rage in New York. (Hong Kong’s exchange also reportedly aims to allow SPACs.) In China, the STAR market in Shanghai and the Growth Enterprise Market (GEM) in Shenzhen have dropped their requirement for companies to be profitable before they can seek an IPO, making them a bit more like Nasdaq.

“You will see two kinds of markets develop: one which is more local, and one which is global,” Azar said. “For the global, I think New York will remain the leader.”

The future of China’s IPO market

—Jane Li, tech reporter in Hong Kong

The short version: China’s IPO market is big and thoroughly Chinese. It seems likely to stay that way.

IPOs in Asia Pacific, led by exchanges in mainland China and Hong Kong, routinely outnumber and out-raise other exchanges around the world. The bourses in Hong Kong, Shanghai, and Shenzhen ranked second, third, and fifth in terms of IPO proceeds raised globally last year, according to consulting firm KPMG. Five of the top 10 IPOs by funds raised were either in Hong Kong or the mainland.

Size doesn’t tell quite the entire story, however. Part of the reason China’s stock market is so large is because equities are among the few investing tools available to Chinese investors, said Ringo Choi, EY’s Asia-Pacific IPO leader. Until recently, IPOs were basically free money for those lucky people able to get a piece of them: companies looking to list on the mainland had to be profitable and they weren’t allowed to offer shares at a price-to-earnings ratio any higher than about 23, even though the company’s PE ratio might be much higher. This forced companies to price their shares at an artificially low level—and those shares could skyrocket 300% or more on the first day of trading, resulting in immense demand from a massive base of retail investors. (Some newer “Nasdaq-style” exchanges have looser controls on PE ratios and don’t require profitability.)

Companies that list on the mainland are generally expected to be incorporated there. But China reportedly has global IPO ambitions: Authorities are considering ways to entice Chinese companies that are listed offshore, in the likes of Hong Kong and New York, to have a listing on the mainland. There are indications they would like to see global multinationals, like Tesla or Apple, carve out their Chinese operations and list them on the new exchange.

But there are several things holding mainland exchanges from becoming the next New York Stock Exchange, including capital controls that make it difficult to get money in and out of the country.

The biggest uncertainty comes from its unpredictable regulatory regime. International investors got burned when Ant Group’s IPO was suspended by Beijing at the last minute before its debut in November. (If Ant tries to list again, the new valuation could reportedly be as low as $29 billion thanks to new regulations—some 10 times lower than the expected valuation last year.) Fang Xinghai, the vice president of China’s securities watchdog, said at a conference earlier this month that while Beijing welcomes foreign investors, it could also suspend trading from those institutions if they are deemed as causing “huge volatility” to the market.

Hong Kong, on the other hand, has a foundation for becoming an international market. The US has threatened to crack down on Chinese companies listed on Nasdaq and NYSE, which resulted in a wave of Chinese companies taking out a secondary listing there. The city provides a way for international investors to get access to the Chinese companies listed on its exchange, and mainland companies that use Hong Kong’s bourse to get access to foreign currency—something that’s not easy to get in the rest of China.

But some question whether international investors will continue to favor Hong Kong, as China tightens its grip on the former British colony and strips away Western-style freedoms. While Hong Kong is clearly an important financial center for China, University of Florida finance professor Jay Ritter isn’t convinced it will remain vital for foreigners.

“Hong Kong continues to be the kind of center of Asian financial markets, but Singapore is definitely a beneficiary of China’s crackdown on freedom in Hong Kong,” he said.

What’s next for SPACs

The short version: Nobody thinks the SPAC mania can continue the way it has. Even so, these “blank check” companies are going to remain a bigger fixture of the IPO market in the future.

Here’s how SPACs work:

  • A sponsor lists the SPAC on a stock exchange through an IPO. The SPAC’s purpose is to acquire an as-yet unidentified private company, taking it public through the merger process.
  • Since investors don’t know the target of the investment, they usually put up money on the basis of the credentials of the sponsor. (Some recent examples include big-time hedge fund investor Bill Ackman and former Facebook executive Chamath Palihapitiya.) The sponsor may have expertise in a certain geography and sector, like technology, and plan to focus on investments in those arenas.
  • Once the SPAC has raised funds through the IPO, management may have 24-months to find an investment target and finish the merger.
  • Investors in the pre-acquisition SPAC usually get stock at $10 a share as well as warrants that give the investor the right to buy shares at a certain price and date (the warrants can often be exercised if shares rise to $11.50 some 30 days after the SPAC merger has been consummated). Think of the warrants as a sweetener to investors who are making a blind bet.
  • Investors get to vote on whether to accept the merger and can get their money back, plus interest, if they decline. They also get to keep the stock warrants even if they take their funds back.

It may seem odd to have a SPAC renaissance in the middle of the worst pandemic in generations, but Golden Falcon chief Azar says it was no coincidence: The IPO market dried up when the Covid-19 fears peaked last year, but SPACs still had their blank checks handy, making them one of the new sources of capital available. That attracted big-league sponsors who might have ignored the SPAC market in the past. That in turn attracted higher quality companies in a kind of virtuous circle. Azar says business owners who used to do traditional IPO have been impressed by the SPAC model: “They have since said, ‘listen, we’re never going to go back to doing a regular IPO,’” Azar said.

A big advantage to a SPAC is that they are faster—the process might be half as long as a regular IPO. And instead of the valuation of the acquisition target being set by the broader stock market, it’s decided between just two parties—the SPAC management and the merger target. That reduces the risk that an IPO gets disrupted by unforeseen turmoil in the stock market. And unlike in a regular IPO, SPAC managers can show future financial projections. Proponents say this makes more sense for fast growing companies that are running losses but have a big market opportunity in front of them.

That said, SPACs have their downsides. Sponsors usually take a big chunk of stock: They may get 20% of it, which dilutes the IPO investors’ shares. As some SPAC sponsors have taken advantage of the construct to sell unrealistic future projections, the SEC has cracked down on blank check companies, making it harder for them to raise money.

Like most people interviewed for this article, Harry Nelis, partner at global venture firm Accel, says there’s no one-size-fits-all model for companies to go public, even as they have more options than they used to. “There’s pros and cons to each of the routes now available to the public market,” he said. SPACs are “an old monetization product now being applied in a new way.”

Empowering a new wave of founders

The short version: In the US, the disparity between IPOs from white male founders and everyone else traces back to startup funding. The racial reckoning of the past year is keeping a spotlight on this problem.

One thing the richest Americans have in common, from Amazon’s Jeff Bezos to Facebook’s Mark Zuckerberg, is that almost all of them founded companies that listed on the public market. Another thing they have in common is that they’re nearly all white men.

Founders tend to own outsize portions of the companies they create, setting them up for a major jump in wealth if their companies achieve a public listing. But to say that IPO wealth isn’t distributed evenly is an understatement: Only four of the 442 companies that went public in the US last year had women founder-CEOs, according to data compiled by Business Insider and Nasdaq. Of the public companies started by women over the years, most were founded by white women.

The gap traces directly back to funding for entrepreneurs. Put simply, there’s not enough of it going to women and non-white founders for them to scale their businesses and make it to an IPO. Women-led startups got about 2.3% of venture capital funding last year, and the numbers are even more unfortunate for Black and Latinx women: They’ve received 0.6% of VC investment since 2018, according to a report by digitalundivided, a social startup. The median seed funding for Black and Latinx women is about $480,000—one-fifth that of the median for all startups at $2.5 million—even though their rate of failure is much lower.

Even with pressure from #MeToo and Black Lives Matters movements, the mix of venture capital investors, which is a relatively small pool of people with little turnover, is only slowly becoming more diverse. Koh at NextView Ventures senses that more women are getting involved in venture investing, but many of them are still in early-stage funding. Until more diversity filters through to later-stage investing, women- and minority-founded startups may lack the big chunks of money that help power growing companies all the way to the IPO.

“To get the IPO company building journey all the way to the end, you can’t just have access to seed and series A money,” said Koh, who was an early hire Blue Apron and helped scale the meal kit service through rapid growth all the way to its IPO.

“That’s not to say that male investors don’t invest in female founders,” she said. “But I think that it certainly helps to have more diverse ranks of the funders.”

Some numbers seem to have improved—digitalundivided says 57% of the companies started by Black women in its database in 2020 have received funding, up from 40% in 2018. For Latinx women, that figure has increased to about 70% from 64%.

But the gains that non-white women have seen in recent years have been eclipsed by the avalanche of funding that’s gone into firms started by white men, said digitalundivided CEO Lauren Maillian. There’s been an increase in the number of Black and Latinx women who have raised more than $1 million, but that funding pales in comparison to what their white male counterparts are raking in.

“While we see this slow growth and we do see some Black and white women raising a million dollars or more for their businesses, this growth is not fast enough to support the next generation of brands to IPO,” Maillian said. “Those next billion dollar brands, those billion dollar unicorns aren’t going to come to market from women of color founders at this rate.”

Digitalundivided started a Do You Fellowship fund for founders to help get rid of the additional barriers that non-white women face—such as being told their startups don’t have traction and being given unreasonable milestones before getting a check—and make sure their milestones are consistent with the ones given to non-minority founders.

There might be one change: The recent racial reckoning in the US and much of the rest of the world has put a focus on non-white businesses, and that focus has been more durable than in the past, Maillian said. “It is the first time in a long time that you see this pressure sustained for long periods of time,” she added. “But we’re also seeing, again, the continued stereotypes that are making it more difficult for women of color who have the wherewithal, the ideas. They’re still missing those resources to be able to compete and grow or scale their own companies.”

Rise of the retail investor

Short version: Technology has made it easier than ever for retail traders to bet on the stock market. There are signs that executives are starting to reckon with them.

Booms tend to bust. But there are signs that some elements of the individual investor surge will persist.

The retail investing boom started gathering force in late 2019 as brokerage fees disappeared, and the trend accelerated during the Covid-19 pandemic. Lockdowns meant many people had extra cash and little to do with it.

Some are pushing for retail investors to have more access to the IPO market. Regular people can try to buy shares in public offerings through their brokerages, though these institutions have typically been given smaller slices of these deals (if they got a slice at all). Lately there’s been a rethink of individual investors’ place in the listing process. Robinhood, the app that’s synonymous with the retail-trading boom, reportedly plans to give its users access to its IPO. SoFi, an online personal finance service based in San Francisco, says it plans to give members access to public offerings. In the UK, technology platform PrimaryBid works with banks and companies to make IPOs on the London Stock Exchange accessible to the average investor.

If and when the froth comes off the retail frenzy, it’s likely that the new baseline of individual investors will be higher than it was before. Retail trading now accounts for about 16% of the UK stock market, up from a 10% in 2009, according to PrimaryBid. Similarly in the US, individual investors account for about a quarter of the equity market, up from just 10% two years ago, according to Goldman Sachs.

As their influence grows, some companies are engaging with the army of trading minnows: Car maker Tesla and big data company Palantir use the platform Say to get a snapshot of what this investor base cares about so they can address it during earnings calls, product launches, and investor days. If everyday investors keep up their enthusiasm for stock trading, it’s not a stretch to think more brokerages and corporate executives will take their opinions into account, perhaps even during the listing process.

“The democratization of investing is, I think, here to stay,” said Fadi Abuali CEO of Goldman Sachs International.

Reading list

Why firms want direct listings and SPACs instead of IPOs. Understand companies’ frustration with the traditional process, including how often it leaves money on the table.

Should retail traders be able to invest in IPOs like Deliveroo and Robinhood?IPOs aren’t always a good deal for investors. If purchased and held for three years, public offerings have on average underperformed their benchmarks.

How the rocket business launched a wave of blank check acquisitions. In 2019, Virgin Galactic took the first small step for a space company—and a giant leap for global finance. It went public via a SPAC and kicked off a trend.

Is the SPAC craze finally cooling off? A look at the SPAC boom nearly one year in, including how long it can continue.

Why Ant Group’s IPO was suspended. What happened to one of the most anticipated IPOs of the year.

The bonkers IPO market has obscured an important innovation for listings. Learn about Unity Software’s hybrid auction.