Article

Direct listing or IPO: What’s the difference?

by Jennifer Ceran

So you want to take your company public? In the past, the traditional IPO was the most common way to do this, but recently a few larger, well-known brands, notably Spotify and Slack, have opted for the direct listing. I’ve had the privilege of working through two IPOs — first as the VP of Finance with Box, and more recently as CFO of Smartsheet. 

In my opinion, there are pros and cons of both options; what really matters is how you price the transaction, keeping in mind that the best overall IPOs create a win-win opportunity for both existing and new shareholders.

Photo of the New York Stock Exchange, plus the Smartsheet (SMAR) listed banner.

What are the key factors for success? 

Making a successful transition to a public company requires careful focus on several critical factors. 

Market awareness

Investors need to be educated and have a clear understanding of the company’s business model. The more investors that are familiar with the company, the better. Every company should spend the necessary time educating the market about what they do and the potential long-term opportunity. 

This can be done in a number of ways: presenting at private company conferences, conducting non-deal roadshows, preparing the S-1 document, and through public relations as part of the normal course of business. Do not increase press because you plan to go public; that is known as “jumping the gun” and is not allowed.

Companies that are more well-known have the opportunity to consider direct listings, but those that are not might be better off with the more traditional IPO, because the process gives them an opportunity to educate the market. 

Clear, transparent, and objective information

Investors are very savvy; most have reviewed hundreds, even thousands, of company reports in their lifetimes. Investors can see through fluff and intuitively sense when something is not right. 

Whether an IPO or a direct listing, companies should be clear and transparent in their communications and S-1 filing documentation, avoiding too much creativity in trying to make their company appear to be something that it isn’t or using novel metrics that are unknown to the market. A company should also avoid painting an overly rosy picture or leaning in on guidance when it has just gone public. In other words, plan for the downside. 

At the end of the day, investors want to know the facts as well as the risks and the opportunities of the business model as objectively as possible. They want companies to do what they say they are going to do; actually, they would like companies to do better than expected every quarter. 

Bankers have a lot of experience knowing what works and what does not work in S-1 documentation. It doesn’t mean that a company cannot deviate from the past, but they should do so very carefully and with the intent of providing better transparency and understanding of the business in a clear and simple way.

Pricing

Finally, it is critically important to get initial pricing right, and this can be a hard process because investor sentiment changes quickly. One thing is for sure: Getting pricing right does not mean taking the last private valuation and grossing it up.

My belief is that new investors should have an opportunity to garner a 20-30% return in the first year, which is a similar return to what venture capitalists require. Why? Because the first year as a public company brings a lot of risk to the new investor. The management team is unproven, the company is experiencing what it is like to forecast and hit or exceed their forecasts, and some risks, such as competition, may have yet to reveal themselves to management or investors. Investors need an appropriate discount for this uncertainty.

In a direct listing, there is no inherent discount given at pricing, which means there is greater risk for buyers. This is why we typically see stock prices decline in the first 12 months. These stocks are priced for perfection, and we all know how hard it is to be perfect. Investors who buy at the open may sell immediately to protect them from the downside risk.

One may ask why investors buy at all. It might be the case that bankers encourage investors to sometimes buy companies with little to no valuation discount in exchange for getting better discounts in other IPOs in the future. 

On the other hand, in an IPO, pricing discounts demonstrate incredible volatility and can be as high as 80%. That’s too much. Bankers work for both buyers and sellers trying to strike a balance between giving buyers an appropriate discount for risk, and giving sellers a reasonable price with which to raise capital. A reasonable discount is no more than 30%.

What needs to change?

With all the efficiencies being created in the marketplace today, I think the traditional costs of going public should be rationalized by 20-30%. No longer do companies need to spend nights with their accountants, lawyers, and bankers at the printer; today, this can all be done online.

The SEC appears to have gotten more reasonable in their list of follow-up questions (assuming you follow traditional protocols), saving additional time as well. If companies spend more upfront time in the education process, the banker role becomes easier, too. The traditional 7% fee should come down by at least 1%. (Note that these fees are also used to cover banks’ research costs, so they can’t go down by that much.) The more banks on the cover of the S-1, the higher this fee should be. 

If you’re thinking about going public, read my four insider tips to make the journey easier, more efficient, and less costly.

Jennifer Ceran is chief financial officer at Smartsheet. With more than 25 years of work experience in the US and internationally, Jennifer is passionate about creating high-performing teams. She has frequently been recognized by Treasury and Risk Management magazine as one of the “100 Most Influential People in Finance.”