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The IPO is evolving. In this era of extraordinarily easy money, cash-rich startup execs are calling more of the shots: They are waiting much longer to brave the public markets and, when they do it, they want the process to be cheaper and more streamlined.
Or, as Spotify CFO Barry McCarthy put it at a Goldman Sachs event: “For a long time I have watched the public market and thought it was chronically broken.”
Broken is a strong way of putting it—given the shenanigans at unicorns like Uber and Theranos, private markets aren’t exactly the embodiment of efficiency. But Spotify, along with law firm Latham & Watkins, is credited with overhauling the direct listing when Spotify went public in 2018.
Unlike an initial public offering, direct listings aren’t underwritten, which means there’s no Wall Street bank standing behind the deal offering its stamp of approval (known as certification), due diligence, marketing, and price support when the stock starts trading. A stock that goes public via a direct listing may (initially) get less analyst coverage. But shareholders can sell their stock in the public market right away without agreeing to a 180-day lockup period, which is typical for IPOs.
University of Florida professor Jay Ritter, an IPO expert, says underwriter services “can be oversold.” Audited financial statements from a Big Four auditor can help provide certification. In the longer run, the presence of analyst coverage depends on the company’s performance, regardless of how it goes public.
Another critical difference for company using a direct listing is that the price is set in the opening auction—the same mechanism that cranks up stock trading each day when the exchanges open. This differs from an IPO where the underwriters and the company set the offer price, which is typically at a discounted level that rewards Wall Street’s favorite hedge fund clients, Ritter says. Investors are more likely to get included in the IPO if they’ve spent a bunch of money on trading commissions, a big source of revenue for investment banks.
The IPO method may ensure that there’s plenty of demand on the opening day, but it comes at a cost for the company’s existing stock owners. Spotify’s McCarthy describes it as artificial demand. “We wanted market-based price discovery,” he said.
This sounds like bad news for an investment bank like Goldman Sachs, last year’s top underwriter of IPOs in the US, according to Dealogic. The advisory fees for direct listings are lower than underwriting charges, and it puts some trading commission revenue at risk.
But direct listings could inadvertently strengthen a small number of top-tier investment banks. The traditional IPO may have five or so bookrunners, meaning five investment banks have to share the fees. Not so with a direct listing: “If Goldman Sachs or Morgan Stanley does a direct listing, they get all of it and they don’t have to share it with the competition,” Ritter says. Smaller banks can get squeezed out. Morgan Stanley and Goldman, the world’s top IPO bookrunners last year, were the advisors for Spotify and Slack’s direct listings.
Some legal issues, such as liability when the stock drops after it was listed, are still being ironed out (paywall). But more direct listing are almost certainly on the way. Unlike the ones so far, which don’t allow companies to raise new capital, the New York Stock Exchange is looking to make them more flexible with a proposal that would allow companies to sell shares and raise money. The exchange has refiled its proposal after the first was denied by the Securities and Exchange Commission, and Ritter thinks some form of this type of direct listing will get approved eventually.
There are signs that fund managers and regulators are getting more comfortable with direct listings. Goldman Sachs says some investors who sat out the Spotify direct listing were big players when Slack launched its own direct listing. Greg Rodgers, a partner at Latham & Watkins, said the firm’s conversations suggest there will be at least five direct listings this year.
They may remain niche—lesser-known companies could still need the full suite of IPO services, such as underwriting and the (initial) guarantee that analysts will cover the stock. In the meantime, the evolution is one more indication that, on Wall Street, it pays to be big.
Next week I’m speaking with Viktor Nebehaj, co-founder of London-based brokerage Freetrade, in a Quartz membership conference call. The ex-Googler and I will discuss entrepreneurship, the digital brokerage scene, and we will also be taking questions from Quartz members during the video call on Jan. 14 at 11am ET (4pm GMT). If you’re not already signed up and would like to support our journalism, you can join here.
This week’s top stories
1️⃣ Currency service Travelex has resorted to manual pen and paper processing after a hacking attack took out its computer systems. The possible ransomware attack attack has disrupted some UK banks’ ability to offer foreign banknotes to travelers.
2️⃣ Goldman Sachs is giving investors a better look at its digital retail bank, which the CEO complains is under-appreciated. The reorganization will help analysts compare the lender to its competitors.
3️⃣ A UK survey suggests that “pay later” offerings like Klarna’s may be having a bigger-than-expected impact on credit scores. The Swedish company told Sifted that less than 0.5% of its UK customers have had scores affected because of missed payments.
4️⃣ Brits aren’t very faithful to startup financial apps like Monzo and Revolut, FT Alphaville reports. Many of the users of these upstarts also use other apps—particularly those of traditional banks.
5️⃣ Singapore has received 21 applications for its five available digital banking licenses. And authorities in Thailand admit the country has fallen behind, according to Bloomberg.
The future of finance on Quartz
A mountain of risky leveraged loans is building up, and US and EU regulators aren’t entirely sure who is holding them. While banks are carrying the majority, some of the dodgiest junk debt is accumulating in the shadows.
Wall Street has been trying to get a piece of China’s financial markets for years, with false starts going back decades. Fraser Howie, who was involved in one of the earliest ventures, thinks this time could be different.
Women invest less than men and often have lower retirement savings. Now, they are building more financial services companies for women.
Elsewhere in Quartz
The world is getting older. In the US alone, 10,000 baby boomers turn 65 every day. Over the next 30 years, many of them will move into nursing homes and assisted living. As they do, they’ll redefine what senior living looks like, writes Quartz’s Lila MacLellan in this week’s field guide for members, giving birth to an era of “geriatric cool” and a new luxury industry that caters to it.
Always be closing
- Starling may look to go public in 2022. The British startup bank’s CEO says it aims to break even by the end of next year, which would make it a rarity among financial upstarts.
- HighRadius secured $125 million of investment. Iconiq Capital led the funding round in the order-to-cash and treasury management company.
- Roofstock raised $50 million. SVB Capital led the deal for the marketplace for single-family rental homes.
- Corvus, a commercial insurance provider, got $32 million in funding.
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