The moos were deafening, a thundering herd so loud I held the phone away from my ear. My new client was a cowboy. (Yes, a real one.) He was herding cattle and was a participant in the friends-and-family program for a hot initial public offering. It was high noon, the first day of trading, and his shares were flying. Although we had no idea at the time, they would close over five times the initial offering price by the final bell.
Giddy up, cowboy.
I doubt everybody was happy. A first-day bump of 10% in price is the industry rule of thumb for a well-priced IPO. Which means that early-stage investors, like venture capitalists who sold at the offering price, left lots of money on the table.
Spotify, the Stockholm-based streaming-music company, is exploring a solution to this problem, pursuing a plan to list its shares publicly without raising new capital. The process is known as a “direct listing,” and investment bankers are understandably worried. Because if Spotify is successful, other companies will follow its lead, pay lower fees to Wall Street, and eliminate the vagaries of IPO pricing.
What do “un-IPOs” mean to wealth management?
On one level, direct listings mean fewer investment-banking handoffs to broker-dealer advisers. Goodbye, competitive advantage.
But on a more fundamental level, direct listings put the wealth-management industry on notice: If clients are anything less than happy with our services, somebody (probably from Silicon Valley) will reverse-engineer the problem, fix it, and put finance-first-technology-second advisers out of business.
Fewer guesses, lower costs
To learn more about direct listings, I spoke with several investment bankers, none of whom are involved in the Spotify transaction. One pointed to Facebook’s IPO as evidence of the difficulty in pricing high-growth companies.
In May 2012, Facebook went public at $38. About three months later, its shares fell below $18, a disaster then, a so-what now as the social-network giant is trading around $170. But like my cowboy example, its early performance shows that IPO pricing is more art than science.
Direct listings eliminate the guesswork. After listing their stock on public exchanges, companies wait for their share prices to settle into a trading range. When they need fresh capital, they sell new shares to the public. In effect, they are bypassing IPOs and positioning themselves for secondary offerings, where the syndicate desks of investment banks rely on the markets rather than educated guesses to set prices.
Companies still file with the Securities and Exchange Commission for direct listings. And while they are likely to hire I-bankers for guiding them through this process, advisory fees are typically less than IPO fees, which can be as much as 7% of the total capital raised.
One investment banker said that Spotify is an outlier, that most private companies lack the prerequisites to bypass traditional IPOs. Spotify is a household name, he says, a unicorn (private tech company valued over…