IPOs, Direct Listings and SPAC’s

Last Wednesday Coinbase went public with a valuation of $85 billion through a direct listing. Direct listing is a lot different than doing an IPO especially for the company’s balance sheet. Before we explore the distinction, it is important to understand how we go here.

In 1929 the US experienced the worst financial crisis the world and the US economy had ever seen. This happened for a plethora of reasons one of them being the lack of uniform standards and reporting requirements. There was a huge information gap between what companies were required to disclose and what they did disclose, it was essentially the wild west of trading securities. I think of the scenes of “The Wolf of Wall Street” where Leo is calling people on the phone telling them he has a “great deal”. Although that wouldn’t be stopped by what I am about to describe this behavior was even more rampant in the 1920’s.  

In response to the crash of 1929 Congress passed the Securities Act of 1933 which established the SEC, Securities Exchange Commission. The SEC then went on to set standards and regulate how companies were able to come to the market and standardized the process in which they do so. Fast forward 87 years and there are three distinct ways that a company can enter the market to be traded as a public company.

IPO

In an IPO, Initial Public Offering, a company raises new capital. This is by far the most popular way that companies enter the public market. This is new capital to the company and is used for them to invest in projects that are designed to make the company more efficient. For example, in 1997 when Amazon went public they said they would use the money to buy more books. Clearly their business model has evolved over the past two decades. In an IPO a company looking to go public hires an investment bank who underwrites the deal and gauges interest among institutional investors and the public and then determines the price and quantity of shares that will be issued. This process comes with a lot of disclosures where the company is looked at under a microscope and has a lot more headaches to deal with than simply being a private company where they can make their own decisions unencumbered by shareholders. Through all the headaches after the company, the investment bank and the SEC all agree the company is traded on an exchange. This comes with a lot of restrictions for all parties involved however the company is on the market and can be traded by investors.  

Direct Listing

Direct listings are the second way for companies to go from being privately held to publically traded. This process allows current shareholders, usually employees and investors from seed rounds, to directly (hints the term direct listing) sell their shares to the public. This still requires reporting to the SEC however there are several advantages for this method. For one there is no lockup period which in an IPO denies insiders the option to sell shares for the first 180 days following the offering. Another huge benefit for the company is that it is cheaper to do a direct listing. Instead of the company paying five to seven percent to an investment bank they can now save that money. The most important distinction between and IPO and a direct listing is that the IPO generates new money to the firm and the direct listing does not.

In the IPO the company dilutes it percentage of ownership by selling new shares in exchange for new capital. On the other hand, with the direct listing the company is selling existing ownership which is a liquidity event opposed to a cash event. Instead of raising new capital for the company as is done in the IPO, employees and the company are simply converting their equity positions into cash, this just transfers the equity from one person to another, it does not create more equity. The last distinction is in the way that the price of the shares are determined. In and IPO the investment bank decides a predetermined price based on a variety of factors. In the direct listing the exchange sets a reference price at what they think investors will buy and sell. Investors have the option to buy at that price or move it higher. In the case of COIN the reference price was set at $250 however no trades were executed at that price because it was determined too low. Instead the first trade was executed at $409.62.

Employees of Coinbase celebrate as they watch the ticker of COIN outside of NASDAQ HQ.

SPAC 

The third was for companies to make an entrance on the public trading floors is through a SPAC. SPACs, Special Purpose Acquisition Companies, are companies that are created simply for the purpose of going public. There is no underlying business, just the intention to raise capital via going public and then, after already publically traded, the company acquires an established company. The benefit of this route is it allows the company being acquired, to go public in a way that is significantly quicker and cheaper than going at it through IPO or SPAC. SPAC are often referred to as “blank check companies” because that is essentially what an investor is doing when they invest in that company, handing the SPAC a blank check to invest in whatever they think is best. SPACs are a relatively new way to raise capital and have become increasingly popular with over the last few years. The major downside to the SPAC is the underlying company loses control to the process.   

It is important to understand the difference between these three because over the next decade it is anticipated that we will see a lot more of the last two. Understanding how they work as well as why a company would want to use one over another is increasingly important. Two decades ago tech companies would go public via IPO however as we saw with COIN companies will have to find creative ways to get to market. As cryptocurrency becomes more mainstream and more popular I anticipate seeing other companies tied to the crypto space go public via direct listing and SPAC.

10 comments

  1. abigailholler1 · ·

    Very informative post, Sam! I find the growth in popularity of SPAC’s kind of insane, since they’ve actually been around quite a while (since the 90’s!). There is quite a bit of risk with SPACs – for one, the targeting process can be long, and the time pressures that the SPAC management team is under can lead to overpaying. Additionally, I’m always curious what percentage of SPACs never successfully find a target within the required time period. I’ve tried googling this statistic before, but haven’t had any luck finding a reputable source. In these such cases, SPACs carry the risk of locking up an individual’s investable cash for an extended period of time with no return on investment if a suitable target isn’t found. A pretty wild concept if you ask me!!

  2. ritellryan · ·

    While I had heard of SPACs before, I never knew what they were, so thank you for sharing! I can imagine that what Abigail said happens pretty frequently. It is kind of saying you are going to buy a company because you need to do so and it might not be the best option, but it is the best at the time so you have to go with it. I can’t imagine these are successful all that often. I do know that direct listings have grown in popularity the past few years, and being able to save on not paying a bank and sell the shares immediately are obviously the biggest selling points to doing so. I can see that trend continuing on as many of the companies tend to be developing products to bring information or products directly to the masses so it makes sense to cut out the middle man in order to go public.

  3. conoreiremba · ·

    Sam, I was eagerly awaiting this blog after you gave us the heads in class and you have not disappointed, and a very timely insight into direct listings. I had seen that the Coinbase COO had said their reason for going public by direct listing was because it was in keeping with the “true spirit” of crypto being allowed to set its own price, so thank you for shedding light on the hidden advantages that they were trying to mask.
    Really nice summary of SPACs and in addition to what you mentioned, I think another reason for their popularity is because of the amount of money that is now invested in private equity, and SPACs provide a viable exit option. But I still think of it as a bit of a “wild west” at the moment and the one example I think of is Nikola Corp the electric truck company who went public via SPAC, convincing the market they had a working protector (they were accused of staging a video by using a hill to show the car moving on its own, wild!). https://www.nytimes.com/2020/09/21/business/nikola-trevor-milton-resigns.html
    So I think the space will definitely become more regulated but it’s great to see increased innovation in changing the traditional landscape for companies looking to go public in today’s world. Really nice post and a great crash course.

  4. therealerindee · ·

    Thank you for succinctly laying out the pros/cons of all of these. I agree with all of the previous comments in that the current opacity and lack of regulation regarding SPACs poses a bit of a problem. We have already seen what I would call the failure of the SPACs that self proclaimed hype man Chamath Palihapitiya pumped up at the beginning of the year. Much like a lot of things in the financial markets, SPACs became the “it” thing, and now they are mostly facing a correction. As you stated, they are pretty interesting for the companies that are acquired as they are a way to break onto the public market while also receiving what we would hope is some sort of guidance by the members of the SPAC. On another note, it’s pretty interesting to me that direct listing seems like the most volatile way to enter the market and that the exchange for all the super volatile assets chose this to be the best route. Also, why are those girls not wearing masks? Mouths just wide open standing right next to one another. What is this, 2019???

  5. sayoyamusa · ·

    I appreciate your great summary of IPOs and new alternatives as I struggle with my finance course this semester. I was surprised to know in the class discussion that the recent Coinbase IPO price was over $300. Investors seem to be very excited about cryptocurrency platform business, so I’m just curious whether this will be here to stay or will be a bubble to burst like dotcom…? Also, one thing I’ve found impressing is that the U.S always develops financial regulatory systems to support start-ups by managing risks such as private equity and chapter 11 etc. Direct listings and SPACs are also opening opportunities to younger tech companies to issue equity and raise funds (I’ve heard NYSE changes the rule to make it possible for direct listing to raise capital.) It is amazing that all the financial systems are integrated to encourage innovations in the Corporate America.

  6. shaneriley88 · ·

    Well done, Sam! I was looking forward to this after you laid claim last week. I really like how you broke out the three methods and added in some typical use cases. SPACs popped up a bit during my internship through interactions with a few PE clients. I this blog and the prior comments existed prior!

  7. shaneriley88 · ·

    Well crafted post, Conor! It’s interesting to see how tech ( via apps) has led to a sort of sports betting 2.0. In many ways, I’d argue that DX regarding sports betting has made “locked” mobile betting in as the invisible addiction. You can lie to an app, you don’t need to know a bookie or a turf accountant, nor do you need to spend a Saturday “watching the dogs”. I think that many other issues or topics of concern that face state and federal governments will overshadow the lurking iceberg that is mobile betting. I enjoyed reading about the apps designed to manage access and Erin’s comments on how it has likely driven viewership and expanded fan bases for many sports. In the future, I wonder if/when/how regulators will take a more firm and digital stance on the subject.

    1. shaneriley88 · ·

      Misfire. Greats posts all around!

  8. Nice clarification of a complex topic.

  9. courtneymba · ·

    Awesome post! This is really informative and actually pretty timely for me. My company just went public two weeks ago via a SPAC – nowhere near the splash of Coinbase lol! I’ve been wanting to learn more about SPACs vs IPOs but the content felt so dense and technical. This is a really great overview as others have noted.

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