Initial public offerings (IPOs) have long been the primary channel for companies to enter the capital markets. By using investment banks to underwrite and manage marketing, roadshows, and regulatory requirements, the IPO process allows companies to create market support for a stock and increase the newly-public company’s chance for a successful opening day. But the recent slew of buzzworthy brands going public has demonstrated growing popularity in foregoing this method in favor of less traditional ones. In April 2018, music streaming giant Spotify turned to the less common alternative of a direct public offering (DPO) for its trading debut. Now, more companies—such as Slack, which went public in June 2019, and iHeartMedia—are turning to this increasingly popular approach.

What is a DPO?

In an IPO, a company generally raises new capital that is underwritten and marketed by a financial institution and is subject to a lockup period in which legacy shareholders are prohibited from trading for a defined period of time. In contrast, a DPO occurs when a company’s legacy shareholders have the option to sell their ownership directly into the public markets without the use of an intermediary or any new capital being raised for the company. A DPO provides liquidity to legacy shareholders, provides a path for the company’s future capital raising, and may provide increased business opportunities since the market obtains transparent access to key company information on a regular basis. DPOs have recently become popular within the technology industry, particularly among well-known companies that do not have a current need for capital.

While occasionally resulting in a faster and more streamlined process, a DPO is not the right approach for all companies. A DPO should be viewed as an alternative, rather than as a shortcut. Before deciding whether a DPO is right for your company, companies should understand what differentiates this growing trend in the capital markets arena.

• No New Capital or Dilution: DPOs do not raise new capital or issue new shares. Legacy shareholders can immediately sell their shares in the public markets. As a result, legacy shareholders are not subject to potential dilution, or the decrease in ownership like in an IPO.
• No Lockup Period: Legacy shareholders may sell shares in the public markets at any time after the DPO and are not subject to a lockup period, providing such legacy shareholders with immediate liquidity, if they choose.
• No Underwriters or Intermediaries:. Instead of using investment banks, underwriters, and broker-dealers, the company uses advisors to assist in the process. As a result, the company avoids hefty underwriting fees, but may experience a “harder landing” into the public arena and potentially more post-offering volatility.
• No Marketing or Roadshows: Companies undergoing a DPO do not market the shares or hold roadshows to solicit investor interest and set pre-trading prices.
• Different pre-trading price expectations: In the DPO pre-trading period, the exchange provides guidance on a potential share or “reference price.” In an IPO, the mid-point price is generally used until the roadshow conclusion when the pre-trading price is established.
• No Over-Allotment (“Greenshoe”) Option: In an IPO, a greenshoe option allows an underwriter to sell more shares than initially planned if the demand for the security issue is greater than expected. This option is not applicable in a DPO.

SEC Financial Reporting Requirements

Similar to an IPO, a DPO must be approved by the US Securities and Exchange Commission (SEC). Companies can generally register under either the Securities Act of 1933 using Form S-1 or the Securities Act of 1934 using Form 10.  Certain sections of the Registration Statements, such as dilution and the use of proceeds, are not applicable in a DPO. In both scenarios, the Registration Statement is subject to the SEC review process, requiring the company and any advisors to address and respond to SEC comments. Once a company is publicly traded, whether via IPO or DPO, it must comply with SEC reporting and compliance requirements, including increased disclosure and public company audits. An emerging growth company (EGC) that undergoes a DPO may still elect certain reporting and compliance relief under the JOBS Act. Overall, the SEC compliance process and requirements are similar to an IPO, with certain exceptions.

The Future of Direct Listings

Although a company does not engage underwriters in a DPO, it still consults with financial, legal, and accounting advisors to plan and execute its listing in compliance with SEC regulations, exchange listing rules, and investor expectations. To be successful, management teams must prepare by aligning internal and external resources to navigate their own pre and post offering complexities and comply with SEC registration and ongoing public company requirements. If a management team is not organizationally ready to be public by way of a traditional IPO, a DPO will not be the answer.

With its distinct advantages and disadvantages, a DPO is not a one-size-fits-all option. Companies must consider all capital markets paths when determining their strategy. For well-known companies that have a diverse shareholder base and no immediate capital need, pursuing a DPO might be the right path.

Riveron focuses on advising clients on technical accounting, SEC reporting, SOX regulatory requirements, finance effectiveness, organizational readiness and financial due diligence to assist management teams in navigating all aspects of their transaction and maximizing value. In IPOs and DPOs, Riveron assists companies with the financial data components of the Registration Statement, audit support, public readiness and ongoing SEC compliance to ensure the newly-public company can reduce risk and optimize efficiencies for long-term success.

**This document does not constitute audit, tax, consulting, business, financial, investment, legal or other professional advice. In addition, this document contains general information, may be based on authorities that are subject to change, and is not a substitute for professional advice or services.