Hot tech companies and other start-ups will soon be permitted to raise money on the New York Stock Exchange without paying big underwriting fees to Wall Street banks, a move that threatens to upend how U.S. initial public offerings have been conducted for decades.
The Securities and Exchange Commission announced Tuesday that it had approved an NYSE Group Inc. plan for so-called primary direct listings. The change marks a major departure from traditional IPOs, in which companies rely on investment banks to guide their share sales and stock is allocated to institutional investors the night before it starts trading. Instead, companies will now be able to sell shares directly on the exchange to raise capital — something that’s not been previously been allowed.
Direct-listing IPOs have been limited to date, as they’ve mostly been used by businesses that wanted to create liquidity events for early investors or management to cash out by selling stock, as opposed to issuing new shares that attract billions in fresh money. In September, workplace management software maker Asana Inc. and Palantir Technologies Inc., the data-mining company founded by billionaire Peter Thiel, used direct listings to go public.
The SEC sign-off of NYSE’s plan follows months of wrangling, including a decision made earlier this year to halt consideration of the proposal at the request of the Council for Institutional Investors, a group that represents major pension funds and endowments. CII had argued that the plan eroded investor protections and might make if more difficult for shareholders to sue over material misstatements or omissions made during the IPO process.
NYSE rejected those criticisms and disputed that the changes will increase risks to investors — arguments that ultimately won out. Getting the rule done under SEC Chairman Jay Clayton, who was appointed by President Donald Trump, might prove important for the exchange and Silicon Valley. That’s because there’s no guarantee an SEC chief picked by President-elect Joe Biden would approve NYSE’s proposal.
Now that the SEC is allowing firms to raise fresh capital through direct listings, both critics and backers agree that they could become much more popular.
“This is a game changer for our capital markets, leveling the playing field for everyday investors and providing companies with another path to go public at a moment when they are seeking just this type of innovation,” NYSE President Stacey Cunningham said in a statement.
One reason start-ups and their venture capital backers might favor direct listings is that there could be less of a gap between the offering price set by bankers and the pop that often ensues on the first day of trading. For instance, Airbnb Inc. opened at $146 a share during its IPO earlier this month, a much higher valuation than its $68 listing price. That arguably cost the company and its early investors $4 billion.
“This is HUGE & will hopefully end 40 years of mispriced IPOs through an old antiquated process,” Bill Gurley, a venture capitalist at Benchmark, wrote on Twitter. “It’s very exciting to see the SEC enable innovation in this way.”
Even if banks don’t underwrite direct listings, they’d still be expected to make fees advising companies that go public. As an example, Palantir paid out tens of millions of consulting fees as part of its offering, according to a regulatory filing.
Under NYSE’s plan, when stock changes hands once trading commences, new shares will get priority over secondary ones. This will give companies a better chance at reaching their fundraising goals. Venture capitalists have long advocated for greater use of direct listings, in part because the arrangements don’t require investors to wait for lockup periods to expire before they can sell their shares.
Some advisers to companies are skeptical that the change will deter businesses from pursuing traditional IPOs. Lisa Buyer, a managing partner at Class V Group, said there are better ways than a direct listing to minimize big gains on the first day of trading, if that’s a company’s intention.
“It’s a construct that doesn’t solve any problem for anyone,” said Buyer, whose firm helps start-ups prepare for IPOs.