It can be confusing to distinguish the different ways new companies can raise capital. So what are the differences between IPOs, direct listings, and SPACs?
Jan. 13, 2021
The world of investing is always evolving to the needs of the market and its investors, which is particularly true when it comes to discussing the different ways companies choose to go public.
While IPOs remain popular for the majority of companies and direct listing are the go-to option for larger institutions with plenty of available capital, SPACs offer an alternative fundraising option for smaller companies which may be changing the entire market.
What is an IPO?
An IPO is an Initial Public Offering and is a method used by companies to raise capital by listing shares on a public exchange. New shares of the company are created with an IPO and are underwritten by an intermediary. In a nutshell, the intermediary works with the company by:
- helping to decide the initial offer price for shares
- assisting with certain regulatory requirements
- buying all the shares and then selling them to investors through their distribution networks
Before the IPO, the company and the underwriter partake in a 'roadshow', where the company's top executives present to investors to drum up interest in the stock. This event can take a long time and often results in a company having to wait for months, or sometimes up to a year, to receive any capital from the IPO.
IPOs come with some disadvantages though, as the underwriter charges a fee per share which can range from 3% to 7%. This means that a significant portion, sometimes totaling in the hundreds of millions, of the capital raised goes to intermediaries.
What is Direct Listing?
Direct Listing Process (DLP) is also commonly referred to as Direct Placement or Direct Public Offering (DPO). If a company wants to go public but doesn't have the resources, or want, to pay underwriters, or have the time for a long traditional IPO season, they may proceed with a direct listing process.
In a direct listing, the company sells shares directly to the public without the help of any intermediaries, which means it saves on fees compared to an IPO. In addition to this, companies that opt for the direct listing process also tend to avoid the usual IPO restrictions such as lockup periods, which prevent insiders from selling their shares for a specified period of time. Furthermore, a company can avoid diluting any existing shares since no new shares will be created in the process.
However, direct listings also come with some risks for the business and indeed their investors, including no support for the share sale, no promotions, no guaranteed long-term investors, and no defense by large shareholders against any volatility in the share price during and after the share listing.
In December 2020, the U.S. Securities and Exchange Commission (SEC) paved the way for change from the traditional IPO process by announcing that it will now allow companies to raise capital through direct listings.
Spotify was one of the most famous companies to go public with a direct listing in 2018. The streaming company said that it opted for a direct listing instead of an IPO because it offered greater liquidity and allowed its shareholders to sell shares directly to the public.
What is a Special Purpose Acquisition Company (SPAC)?
A special purpose acquisition company (SPAC) represents the most complex type of fundraising for new companies. A SPAC is a company that has no commercial operations and is strictly formed to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.
SPACs don't produce any value on their own -- instead, they are created by investors or sponsors who are experts in a particular industry who then pool their money to buy another company outright. Once the company is public, the funds raised get locked into a trust account and within two years the company, also known as a 'blank-check company', must make an acquisition deal or it will face liquidation.
Unlike IPOs and direct listings, SPACs usually already have underwriters and institutional investors before offering shares to the public which saves the company money.
Small companies can make a tidy profit from selling to a SPAC as it can typically add around 20% to the sale price compared to a normal private equity sale. It also offers business owners a faster IPO process as they have the guidance of an experienced partner. Even better, as most SPACs are run by experienced business investors, young companies benefit from that investment expertise and do not have to worry as much about swinging investment amounts or shifting negotiations.
SPACs do still represent some significant risks for company leaders, including losing control over their company in a way they might have prevented with a traditional IPO process. If the company is managed inappropriately, this can also lead to a company's downfall.
In 2019, one of the most high-profile SPACs involved Richard Branson's Virgin Galactic. A SPAC named the 'Social Capital Hedosophia Holdings' bought a 49% stake in Virgin Galactic for $800 million before listing the company.
The bottom line
In general, larger companies prefer direct listings or traditional IPO processes as they tend to already have enough capital which allows them to make a profit by selling certain shares. Whereas, SPACs are popular with younger companies because they can save on fees, receive a higher valuation, and are usually completed much faster.
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