When Spotify said it would direct sell its shares to the public last year, pundits were skeptical. Up until that point, only smaller companies pursued direct listings, not a major unicorn like Spotify.
“It’s no coincidence that virtually every direct listing in recent memory has involved companies with less than $100 million in value that are essentially orphaned in the public markets,” David Golden, the co-head of Revolution Partners venture capital firm in San Francisco, wrote at the time. “Historically, the direct listing has been the public market debut of last resort.”
In other words, a direct listing bestowed upon a company a black mark, a kind of stigma. Only lesser quality companies would pursue this method, the thinking went.
However, Spotify proved the opposite: high valued unicorns don’t need underwriters. The music streaming service’s listing was a major success. And now Slack Technologies, privately valued at $7.13 billion, is reportedly planning a direct listing.
The emergence of unicorns has undermined a long-standing belief about IPOs. Companies seeking to go public traditionally needed to hire a big investment bank to underwrite the shares, go on a roadshow to promote the stock to institutional investors, and convince analysts to initiate coverage.
But do private firms already worth billions of dollars and trade on the secondary markets like SharesPost really need promotion? In the past, even big companies like Google and Microsoft were bit of black boxes prior to going public. For ordinary investors, there was really little financial information on the business, including market value, until these companies filed a prospectus.
Now that shares of unicorns regularly trade on the secondary markets, investors can gain insight into these companies long before a S-1 and access research reports from SharesPost, CB Insights, and Pitchbook. Indeed, Spotify disclosed secondary trading data in its prospectus. Institutional investors like mutual fund giants Fidelity and T. Rowe don’t wait for unicorns to go public; they already own shares in top unicorns like Uber, Lyft, and Airbnb.
Private unicorns command so much attention that even companies with some red flags face little difficulty attracting investor interest.
Take Snap Inc., the maker of the Snapchat photo app. The company offered to sell shares with no voting rights, a major break from publicly traded stocks. I spoke to an analyst who predicted institutional investors would buy Snap shares anyway because the company was so high profile.
“They have to own these shares,” the analyst said.
The real risk to direct listings is volatility. Should the price of a company that just went public go astray, underwriters can step in to stabilize trading by purchasing or selling shares. With companies that choose to direct list, a lot of shares hit the market at the same time, which increases the change of price swings.
But Spotify’s trading activity proved to be stable. We’ll see what happens with Slack: recent volatility from global trade disputes and the prolonged government shutdown makes going public at this time a little more problematic.
Here’s the irony though. Smaller companies, whom Golden the venture capitalist noted were the only firms that previously did direct listings, are the ones that most need the help of investment banks and underwriters the most when going public.
These companies lack the size and sizzle of big unicorns and therefore need help promoting their shares to institutional investors and the broader public. But investment banks have increasingly consolidated into a few giant firms who are only interested in big deals, said Adam Epstein, founder of Third Creek Advisors, a firm that advises small cap companies on corporate governance.
“You could have a smaller company growing revenue a healthy 10 percent a year,” Epstein said. “But others might say: ‘Who cares? Why are you even going public? It’s a total waste of time.’”
The number of IPOs in the United States have been steadily falling over the past three decades but the number of unicorn and mega IPOs have been rising.
While global IPO volumes declined by 21 percent last year from 2017, proceeds grew 6 percent, thanks to a growing number of unicorns (40 IPOs, raising $32.2 billion in total) and mega IPOs that went public, according to a report by Ernst & Young. Proceeds from unicorn IPOs accounted for 61 percent of all IPO raises last year in the United States, the report said.
Even if a small company goes public, it still faces an uphill climb to gain traction with investors, Epstein said. Unicorns may get all of the attention but about 80 percent of all publicly traded companies command are small or micro-cap stocks worth less than $500 million.
On Nasdaq alone, 45 percent of companies on the index are worth less than $300 million. Yet one third of those companies have no research coverage.
Given its size and prominence, Slack will likely face no such problem. Like Spotify, Slack’s direct listing is likely to attract plenty of investor interest.
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