Spotify made a big splash with its novel approach to "going public." Rather than following the tried-and-true path of an initial public offering – where the issuer sells stock to the public through underwriters – Spotify pursued a "direct listing." But did it really do anything different?
While it is true that Spotify did not directly sell any stock to the public, it did file a traditional form of registration statement, a Form F-1, with the SEC; this is the registration statement that any foreign private issuer would file for an IPO. The Form F-1 contained the typical company information that would be disclosed in an IPO: financial statements, business description, MD&A, risk factors, etc. Spotify went through the traditional SEC review process, including an initial confidential filing and multiple amendments to respond to comments from the SEC staff. It also had to file the customary listing application with the New York Stock Exchange.
So what was different about Spotify's registration statement? Two things are notable. First, the filing registered outstanding shares for resale by existing Spotify stockholders. Once registered, those shares could be sold to the public in the manner described in the filing.1 Second, the filing was a "shelf" filing, meaning that the stockholders whose shares were registered were not committing to sell their shares in any particular transaction but were free to do so in their discretion from time to time. Although relatively rare, some companies do include selling stockholders in a traditional IPO, but those shares are sold at the closing of the IPO together with the shares being issued by the company and not on a delayed basis.
So Spotify's direct listing presented an odd case: Spotify did not sell any shares, and none of its stockholders was committing to sell any shares. What if none of them did? In that case, there might be no shares to trade and no way to fulfill orders for shares. Obviously the NYSE got comfortable that this outcome was – at least in Spotify's case – very unlikely to occur, and it turned out to be right.
But will other companies have the same opportunity? Spotify was unusually well situated for its direct listing to succeed: as a consumer-oriented company, Spotify was practically a household name; there was widespread media coverage of the transaction; and Spotify enjoyed a tremendous valuation, generating interest among potential new investors. There was every reason to think that Spotify would enjoy a sustained and liquid market for its shares after the direct listing.
Not every company seeking to emulate Spotify's success will enjoy similarly favorable circumstances. But what are the minimum requirements for a company seeking to pursue a direct listing? Under the NYSE rules, U.S. companies must generally satisfy several basic listing criteria, including (1) a minimum market value of its publicly held shares of $100 million (a much higher threshold than the $40 million minimum for IPOs), (2) at least 1.1 million publicly held shares, (3) at least 400 holders of at least 100 shares (also known as "round lots"), and (4) a minimum price of $4.00 per share. For a company pursuing a direct listing, the NYSE requires that the listing be made in conjunction with a resale registration statement like Spotify's. However, even with a resale registration statement, many venture-backed private companies may face challenges meeting one or more of the NYSE listing criteria without the broad public distribution of shares that usually accompanies an IPO. For example, shares held by directors, officers, their immediate families and 10% stockholders are not considered to be publicly held, so private companies with ownership concentrated among founders and a small group of investors may fail the minimum requirements for the market value and minimum number of publicly held shares. They and other companies may also fail the minimum round lot holder requirement; many pre-IPO companies get nowhere near that number.
Interestingly, the NYSE recently revised its rules to make it easier for private companies to follow in Spotify's footsteps. Private companies seeking to demonstrate that they satisfy the NYSE's minimum valuation requirement for a direct listing can establish that valuation by providing an independent third-party valuation from an experienced investment bank as well as the most recent trading price of the company's stock on a recognized private placement market. The NYSE will use the lower of the two valuations. Under the revised rules, a company whose shares are not traded on a private placement market can also qualify by providing an independent valuation demonstrating that its publicly held shares are worth at least $250 million.
Although the $250 million benchmark may be a high hurdle for many companies, in a rising market more and more companies may be eligible to pursue this path. Even so, it seems that Wall Street can breathe a sigh of relief that the role of the IPO underwriter is alive and well, with direct listing a real option only for unicorns among unicorns.
Footnotes
1. It is a very common misconception that, once a company goes public, all of its outstanding shares become freely tradable. In reality, shares can only be sold publicly if they are properly registered or if there is an available exemption from registration. Many pre-IPO stockholders, particularly insiders and other affiliates, don't have a readily available exemption from registration, or the exemptions that are available permit them to sell only small amounts of stock.
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