With data analytics software company Palantir Technologies set to do a direct listing next month, and with a number of successful high-profile direct listings over the years such as MetroBank & Pennpetro Energy (LSE 2017), Spotify (NYSE 2018), and Slack (NYSE 2019), can we expect more companies to go for a direct listing in future?

A direct listing (or “by way of introduction” in LSE parlance) is a process for a company to become public without going through the Initial Public Offering (IPO) process. The process makes existing stock owned by employees and investors available for the public to buy and does not require underwriters or a lock-up period, whereas an IPO entails the sale of newly-issued securities to underwriters and their clientele. Direct listing increases liquidity for existing shareholders and is usually cheaper than an IPO.

The main difference is that an IPO raises new capital, whereas a direct listing does not. Of course, once public through a direct listing, a company can raise fresh capital at any time through a rights issue, but would then pay the usual commissions to the stock exchange-approved placement agents/brokers.

Besides raising capital, an IPO has the advantage of bringing shares into the market with less volatility, due to the pre-selling of shares through underwriters, who set a target listing price and then negotiate the sale of shares through their network of investment bankers, broker dealers, mutual funds and insurance companies, at a discount. But the underwriter charges 3-7% fees and the placement process takes time, usually involving a road show.

A direct listing improves liquidity for existing investors in that there is usually no lock-up clause, so they can sell immediately, but this can increase volatility (as its based purely on supply and demand), although usually the supply of sellers is based on each existing shareholders agenda. Some, like Spotify, call this a transparent, market-driven price discovery process (rather than that engineered by investment bankers). Fees in this scenario are very low.

Which brings us back to Palantir Technologies, who announced last week that their direct listing will have a lock-up period. This is bound to be related to its mounting losses ($488 million in 1H2020), where many existing investors may well have been thinking of a quick exit, destabilising the share price in the short term. However, it does demonstrate that direct listings have the flexibility to have a lock-up period and act more like IPOs, if circumstances dictate.

Companies that want to go public through a direct listing are ideally consumer facing with a strong brand identity and easy to understand business models, such as Slack and Spotify (as no underwriters are selling the stocks, the company itself has to be attractive enough for the market).

With the well-established trend of large later-stage private equity rounds (due to an abundance of private capital), companies may not necessarily need to go to the public markets to raise capital in an IPO, but instead rather creates the need for existing investors to achieve liquidity through secondary sales on the public markets through a direct listing.

Decoupling the going-public event from the capital-raise event makes a listing more accessible, and with strongly-branded tech companies having more faith in the markets than in investment bankers, we can expect to see more direct listings in the coming years.