Bloomberg Law
March 5, 2021, 9:18 AM

ANALYSIS: New Rules May Help Direct Listings Snack On SPACs

Preston Brewer
Preston Brewer
Legal Analyst

A new NYSE direct listing rule will not eat SPACs’ lunch—but it may snack a bit.

The SEC approved the NYSE’s primary direct listing proposal Dec. 22, and a similar request by the Nasdaq is pending. The changes afford private companies a new option to raise money on public markets without underwriters, in addition to retaining the prior direct listing option to register shares for existing shareholders. The modification removes perhaps the most significant deterrent to choosing a direct listing over an underwritten initial public offering. The substantial cost savings of a direct listing are likely to draw serious interest, both as an alternative to the traditional IPO and as an alternative to the alternative, the SPAC IPO.

The best candidates for direct listings are well-established companies at or approaching profitability. Coinbase, the largest U.S.-based cryptocurrency exchange, is such a candidate. Coinbase recently chose a direct listing (without a primary capital offering) over an IPO.

The Tastes Great, Less Filling Appeal of Direct Listings

The appeal of direct listings lies in its lower cost (no underwriter fees) and higher offer price. A direct listing’s reference price is typically closer to a share’s market value than the offer price set by an IPO’s underwriter. Selling shareholders may thus capture more of their shares’ true worth.

Day 1 selling is also democratized, with both company and selling shareholders entering the market at the same time. This improves access for retail investors—as opposed to the underwriting model, which generally sells shares to professional investors before shares are publicly available.

Special purpose acquisition companies (SPACs) are brand new companies with no operating business. They go public to raise money for a later merger deal that they must complete within an agreed timeframe (generally, two years), so their appeal as a traditional IPO alternative is somewhat different from direct listings. Their many benefits include: flexible ownership and control, strong track records by experienced sponsors, speed to IPO (and speed getting a merged target public), reduced price volatility, and certainty in capital raised. Direct listings do not provide those SPAC IPO benefits. These two means of going public appeal to somewhat different market segments, and that should provide some protection from direct listings eating into the SPAC IPO market.

What does work against SPACs and SPAC IPOs are their tremendous costs. The fees incurred by SPACs during their life cycle are higher than those of traditional IPOs—far higher than direct listings'—and frustratingly opaque. There is also tremendous—and increasing—competition for merger deals which reduces the likelihood of finding and completing a favorable merger within the roughly nineteen months typically available, thereby avoiding the unpalatable scenario for SPAC sponsors of returning investor money. Another growing concern is that securities litigation against SPACs is rising quickly.

SPACs are in some ways still novel financial products. Plenty of retail investors buying SPAC shares on the Robinhood app (and elsewhere) do not fully understand what a SPAC is and the risks they pose to their investment (e.g., that shares are only redeemable for the initial offer price of $10 a share. Losses for any amount paid above that price after shares became freely tradable on exchanges are borne by the investor).

Those clouds may dampen some of the enthusiasm for SPACs over the longer term. SPAC litigation is a new phenomenon, so there is uncertainty about how those claims will ultimately be decided. When you also consider the 20% company stake given as founder shares, it’s clear to see why investors would have good reason to prefer a company that goes public via a direct listing over a SPAC reverse merger.

Traditional IPOs, which appeal to some of the same businesses as direct listings, may be impacted more than SPACs. Still, underwriters play an important, sometimes crucial, role in the success of an initial public offering, particularly for less-established companies. Direct listings have not yet changed enough to seriously challenge the underwritten initial public offering model.

Bloomberg Law subscribers can find related content on our Securities Practice Center and our new In Focus: SPACs resource.

This article was revised on April 22, 2021 to add the final row entitled “Lockup Period” to the “Paths to Going Public - A Comparison” image.

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