UK: Direct Listings Are An Unlikely Option For Small Businesses

As Spotify espouses the merits of direct listings, doing away with the need for underwriters to lock in investors ahead of a company's public float, Brad Isaac, corporate partner at law firm Fieldfisher, outlines the pitfalls of this approach for small and early-stage growth businesses.

Music streaming service Spotify has been enthusiastically making the case for direct listings since the company floated itself on the New York Stock Exchange in April.

Writing in the UK's Financial Times recently, Spotify's CFO, Barry McCarthy, argued that the process of initial public offerings (IPOs) in the US, which has remained unchanged since the 1970s, is "too expensive and cumbersome".

His view is that the system is designed to benefit the interests of underwriters and investors who buy shares prior to the IPO, ahead of those of the company going public.

A direct listing, by contrast, allows a company to sell shares straight to the public, without paying an underwriter to line up investors at a significantly discounted price.

Mr McCarthy makes several good points in favour of direct listings, but for smaller companies looking to list on one of the UK's exchanges – particularly the London Stock Exchange's AIM market – there are several barriers in the way of "doing a Spotify".

The direct listing process is fine if you are a large company or household name, like Spotify. The public and retail investors will have an understanding of the business and there will already be demand for the stock.

Also, much has been made of the fact that Spotify didn't need to raise money at the time of its IPO which made the direct listing route a viable option. For most smaller and growth companies, accessing new equity capital is a significant motive for seeking a public listing.

For this reason, direct listings are a much less credible option for start-ups and small caps, or companies in certain sectors where specialist knowledge is needed, such as natural resources.

Those companies will still need brokers and investment banks and their contacts with fund managers and institutional investors in order to secure the funding they need.

Direct listings will not avoid the need for lawyers, or accountants or competent persons, for that matter, either – especially if a company is looking to list on the UK's Main Market or raise over €5 million, as they will still need a UK Listing Authority (UKLA)-approved prospectus to offer shares to the public.

There have been discussions about the role of the investment banks in the IPO process and whether they look out for the interests of their institutional clients above those of the issuer.

You may be able to cut the brokers and banks out of the process if you are a Spotify, but this is not an option for the vast majority of companies looking to raise capital from the public equity markets.

The "IPOs" that we see on AIM and the Main Market are generally structured as institutional placings, rather than offers to the public. Structuring the fundraising in this way, for an AIM float at least, avoids the need for a UKLA-approved prospectus and the associated time and cost.

It also provides the issuer with comfort that the funding has been secured prior to issuing its prospectus or admission document, unlike with a retail offering where you would need the banks to underwrite the offer.

For small cap IPOs, it is unlikely that we will see any change in the way these are structured or marketed.

Further down the line, post-Brexit, it will be interesting to see if the UK relaxes the process for smaller companies to be able to offer their shares direct to the public, without the need for a UKLA-approved prospectus – for example, a return of something akin the Public Offers of Securities Regulations which existed prior to the EU Prospectus Directive.

This regime made it easier for smaller companies to be able to access retail investors with simpler content requirements for prospectuses and no requirement to involve regulators.

So, while the direct listing process may be attractive for those private companies with valuations of at least $1 billion and funding already in place, if you are a smaller or unknown company, the chances are you will still need the banks to help you raise the money and to underwrite the offering.

Brad Isaac is a partner in the equity capital markets team at Fieldfisher. He advises on a broad range of corporate finance transactions including pre-IPO and secondary fundraisings, flotations and public company takeovers, with particular experience in the natural resources sector.

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