IPOs vs Direct Listings: what’s the difference?
Companies going public and making their shares available for purchase by the public can be a very exciting event, and there are two main ways a company can do this: through IPOs and through direct listings. If you are planning on investing in first-time stocks and shares, you must be educated in the ways through which you can invest. This means understanding the difference between the ways a company can distribute their shares for the first time on public exchanges.
In this article, we will examine what IPOs and direct listings are. We will also look at the benefits of each of these avenues of going public, and finally, we will compare these benefits. If you are eager to learn more about the stock market and the ways companies can go public, read on.
What is an IPO?
An IPO (Initial Public Offering) is a process through which a private company becomes a public company by offering its shares to the public for the first time.
In an IPO, the company raises capital by selling its shares to institutional and retail investors. The shares are traded on a stock exchange, providing liquidity to investors who can buy and sell them on the secondary market. The process of an IPO involves many steps, including the selection of underwriters, registration with regulatory authorities, and pricing of the shares.
Benefits of IPOS
There are several benefits of investing in new stocks that have gone public through IPOs. They include:
- Higher capital raising
IPOs can typically raise more capital than direct listings, as they involve the issuance of new shares, which can be sold to raise additional funds for the company.
- Greater visibility
There is also typically greater visibility in the form of media attention and investor interest due to the presence of the roadshow process, where company senior management members travel to promote their upcoming IPO. This can lead to greater awareness of the company, and subsequently, greater demand for the company’s shares.
- Investor protection
IPOs are typically subject to more regulatory scrutiny and oversight than companies that go public through direct listings. This can lead to greater investor protection.
What is a direct listing?
A direct listing is an alternative way for a company to go public and start trading on a stock exchange. In a direct listing, a company does not issue new shares to raise capital, but rather allows existing shares held by insiders, employees, and early investors to be sold to the public.
In a direct listing, the company does not work with investment banks or underwriters to facilitate the sale of its shares, as it would in a traditional initial public offering (IPO). Instead, the shares are listed directly on the stock exchange, and investors can buy and sell them freely. Direct listings are becoming increasingly popular among companies that do not need to raise new capital but still want to offer liquidity to their shareholders and increase their public profile.
Benefits of direct listings
Direct listings have their unique benefits, just like IPOs do. These include:
- Lower costs
The first benefit of investing in direct listings is that they typically cost investors less. This is because they typically have lower underwriting fees, and they do not require the company to issue new shares. This can reduce costs for the company and potentially lead to a better outcome for shareholders.
- High transparency
Direct listings may also provide more transparency into a company’s finances and operations because there is no quiet period, which is required during an IPO.
- Great flexibility
Finally, direct listings offer investors a great level of flexibility in terms of pricing and timing, as there is no lock-up period for insiders. This means they can buy and sell their shares immediately, instead of having to wait a designated number of weeks before trading, like many IPO-issued shares require.
Major differences between IPOs and direct listings
The major differences between an IPO and a direct listing are in the process of how the company’s shares become available for trading on a public exchange.
Involvement of underwriters and intermediaries
In an IPO, a company hires an underwriter or group of underwriters to sell shares to the public through a structured process. The underwriter sets the initial price for the shares, which is typically based on the company’s financial performance and the demand from investors. After the shares are sold, they begin trading on the exchange.
In contrast, in a direct listing, the company’s shares become available for trading on a public exchange without the involvement of underwriters. The company itself sets the initial price for the shares based on market demand, and existing shareholders can directly sell their shares to the public.
Structure and speed
Direct listings are less structured than IPOs and do not involve the same level of scrutiny and promotion from underwriters. As a result, direct listings are often cheaper and faster for companies to execute than IPOs, but they also carry higher risk and uncertainty for investors.
Which is better – investing in IPOs or direct listings?
There is no definite answer to whether it is better to invest in IPOs or direct listings, as it depends on too many factors that are personal to the investor. For example, risk appetite, product preference, and trading strategy. It also depends on the company’s financial health, growth prospects, market conditions, and general investor sentiment.
This article only explains the similarities and differences between IPOs and direct listings. If you want to invest in stocks through either avenue, you should contact a financial professional, who can offer you the expert guidance you need to make informed decisions.
What to consider before you choose between them
There is no definite answer as to which method or which type of shares is better. However, it is certainly true that different traders will find their preference by evaluating their personal preferences and conditions. Before you dive into the stock market, you can consider these factors:
Your risk appetite
The first thing you should consider is your risk appetite. Whether you are a risk taker or a more conservative trader, you should have an idea of how much of your funds you can lose.
Your investment strategy
Next, you should consider your overall investment strategy. Think about how you wish to invest, your trading goals, and when you are free to trade. These can all influence how you want to approach stock trading.
The stock itself
Of course, it is essential to consider the stock itself, and whether it is something you want to invest in. Consider its growth potential, its company management, and its financials, such as its past earnings, records of success, and more.
Some final words
In summation, IPOs are the traditional way of taking a company public and involve underwriters who purchase and then resell shares to the public, while direct listings allow companies to list their shares directly on a stock exchange without underwriters or an initial offering price.
Both methods offer advantages, and therefore, ultimately, the decision to invest in stocks through an IPO or a direct listing depends on your circumstances and preferences. It is hugely important to thoroughly research the company and its financials before investing in any stock, regardless of how they come to be public on the stock market.