Insight & Analysis

Record equity markets have sparked trends in direct listing and SPACs amongst US companies, but what are the risks?

Published: Mar 2021

Record equity markets have sparked trends in direct listing and SPACs amongst US corporates, but there are risks for treasury teams when it comes to ditching a conventional IPO. Syndicate banks play a vital role drumming up investor interest, and only companies with a strong brand should go it alone. As for SPACs, finance officers need to understand how much of the company they are actually giving up.

Star fish

The current trend in listing directly began when Spotify went direct in 2018. Back then, executives at the streaming music provider made much of how the company was “re-imagining” the traditional IPO process by ditching the services of big syndicate banks to go it alone on the NYSE. Since then, a small but growing group of companies including Slack, the workplace messaging application, and software companies Palantir and Asana, have also avoided costly investment banking fees to offer shares to institutions and retail investors on an equal basis, allowing them to buy as much as they want and not be held back by allocations. Most recently, Roblox, the video game company, says it too plans to list directly rather than via a conventional IPO.

A direct listing has a few specific characteristics. Companies listing directly aren’t raising more capital – Spotify was only listing its outstanding shares (such as those held by employees and early-stage investors) with no plans for either a primary or secondary underwritten offering. Hence there is no need for the services of big syndicate banks responsible for selling shares and drumming up investor interest. This in turn means none of the traditional IPO characteristics like a limited float and preferential treatment for some investors, lock ups and price stabilisation – or the traditional share price pop.

That pop means money is often left on the table, a bugbear in the IPO process amongst treasury teams whereby under-pricing costs companies dear. In a traditional IPO, underwriters typically set an offer price below where the market price is going to open or expected to pop, passing along profits to investors. If the company had raised cash at the share price after the pop it could have either got more bang for its buck, or sold fewer shares, explains Jay Ritter, an expert on IPOs at the University of Florida. “Money left on the table is money that is not cash on the balance sheet of the company and an opportunity cost,” he says. “The average money left on the table, plus underwriting commissions, worked out at US$200mn per IPO last year. IPOs are very expensive.”

But listing direct is only right for companies with strong brands, an easily understood business and investor awareness. “IPOs are sold and not bought,” cautions Jeff Harte, Managing Director, Equity Research at Piper Sandler in Chicago in a reminder of the vital role of banks in selling companies and building muscle behind an IPO. “At the end of the day IPOs are sold, and pulling them off without roadshows and sales support of Wall Street is difficult.”

Elsewhere, experts flag the process can leave shares thinly followed and without lock-ups, which restrict sales in the early months, vulnerable to falls. An IPO, unlike direct listings, also allow a company to find the sticky public investors at the right price through pre-listing allocations.

SPACs are back

The traditional IPO is also getting a run for its money from SPACs. One of the hottest trends in US investment circles (UK regulation currently discourages SPAC listings) involves so-called blank check companies with an experienced management team and investment focus, but with no assets, floating on the stock market and raising money from investors. The team then hunt and merge with private companies looking to come to market, allowing companies in the SPAC to obtain a stock market listing.

Recent corporate names to take the SPAC route include tourism company Virgin Galactic, the US sports betting firm DraftKings and the electric truck maker Nikola. Luminar Technologies, a company specialising in driverless vehicle technology which came to market via a SPAC in December, made its 25-year old founder a billionaire in the process. According to the website SPACInsider, some 248 SPACs came to market last year raising US$83bn, while 127 SPACs have raised US$37bn so far this year.

SPACs offer treasury teams a quicker route to market and less regulatory bind. SPACs can also be an attractive option for a company struggling to show profits. But treasury teams navigating the SPAC route face a number of challenges. SPACs can be hit by muted investor enthusiasm, making it harder to raise money. Investors (those buying the shares in the shell company – not the asset management team behind the SPAC) don’t always get the best deal because the asset management team take 20% of the equity. Moreover, underlying companies face giving up a large chunk of equity to the SPAC sponsors. Another key risk for treasury teams to weigh is the amount of money the SPAC will deliver to the company. “The process involves quite a lot of uncertainty,” concludes Ritter.

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