IPO vs direct listing: What’s the difference?

Both IPOs and direct listings are methods for companies to go live on a stock exchange, but they’re slightly different. In short, an initial public offering (IPO) is where brand new shares of a company are created to be sold to investors to raise capital (money). This requires the shares to be underwritten. Meanwhile, a direct listing is where there aren’t any new shares created, and the existing shares are sold to investors.

These two methods of floating on a stock exchange are pretty similar, unlike SPACs, which are a totally different kettle of fish.

IPOs

An initial public offering is where new shares are created. The company needs to hire an underwriter to help with the process who deals with regulation and pricing. They buy the shares from the company, then sell them to the public.

As new shares are created, the existing shares, such as any owned by employees or private investors, are diluted. This means that the current shareholders suddenly own less of the company than before – you can think of this in exactly the same way as diluted drinks – we all have our suspicions about the drinks at the local cinema.

So if a company decided to issue 100% more shares than it does right now – doubling its shares, then the percentage of the company that the current shareholders hold would halve.

Companies have to pay underwriters to create new shares, which is typically a small percentage per share. If a company can’t, or doesn’t want to, pay for underwriters, then it can choose to go public with a direct listing.

Some companies that have gone live with IPOs include Airbnb, Snowflake and Bumble. See the list of upcoming IPOs here.

Direct listing

If a company doesn’t want to pay an underwriting fee or doesn’t want to dilute its existing shares then it can choose to list directly. This isn’t a way of raising capital – as there isn’t anything new for the company to sell.

The process involves selling any existing shares – including those that any existing investors and employees own. The main issues with this is that there’s none of the promotion or media hype you usually see. This is typically something the underwriters deal with.

There’s also no guarantee that the current shareholders will want to sell up – and if there’s a lot of interest then demand would outstrip supply, which tends to rise the price. A scenario like this could be frustrating for investors that want in.

Some companies that have gone live with direct listings include Slack, Spotify and Palantir Technologies. It’s also how Coinbase went live on NASDAQ.

Bottom line

A direct listing is just another way for companies to choose to go public. It tends to be the decision made when the company isn’t in need of any extra money. It’s a way to allow current shareholders to sell their portions of the company (known as increasing liquidity).

Frequently asked questions

• Is a direct listing better than an IPO?

  It’s different to an IPO, but not necessarily better. It depends on what the company wants to achieve from the listing. If the company is looking to raise capital, then an IPO is better, if it wants to allow its current shareholders to sell their shares easily, then either works pretty well. If the company doesn’t fancy underwriting fees or doesn’t want to create more shares, a direct listing is better.

• Is a direct listing an IPO?

  No. It’s a different way of listing, but the term IPO is often used to refer to companies planning to go public, whether it’s through an IPO, a SPAC or a direct listing.

• Is a direct listing bad for investors?

  It can work both ways, like all investing, it’s got risks. You should make sure you’re aware of the risks involved before you get involved.