A NEW PATHWAY

From Uber to Jumia and even older technology (tech) companies like Etranzact and Chams Plc, it is arguable that Initial Public Offerings (“IPOs”) have not offered great returns for tech companies in Nigeria and across the globe[1].

Investors are speculating on whether the great tech bubble is about to burst because, considering the cost of IPOs, tech companies have to scrutinise the expected returns when contemplating an IPO. One of the solutions to this cost vs returns conundrum appears to be for tech companies to adopt direct listings.

In this two-part article, we will consider what a direct listing is and what it takes to run a successful one, with Spotify as a case study. The article will also consider the regulatory framework of the Nigerian Stock Exchange (“NSE”) with regards to direct listings.

DIRECT LISTINGS

Founders and Investors involved with tech companies who wish to raise funds from the public now seem to have their eyes set on an alternative way of raising capital from the public. Through direct listings[2]. The major rationale behind the preference of a direct listing over an IPO is the fact that, the costs of underwriting, preparing prospectuses, roadshows for IPOs and engaging investment banks are avoided if a direct listing is used by the company.

What is a Direct Listing?

In simple terms, direct listing is the process by which the existing shareholders of a company and the company itself, sell their shares to the public. So, while an IPO focuses on issuing new shares, direct listing allows a company’s existing and outstanding shares to be listed on a stock exchange without following the customary procedures for IPOs such as underwriting offers, issuing prospectuses and executing lock-up agreements[3].

In a direct listing, shareholders who wish to sell their shares will sell at existing market prices and not at the nominal price of the shares. Spotify Technology S.A. (Spotify) and Lyft Inc. are prime examples of companies that have utilised direct listings to tap into the capital markets.

In most jurisdictions, direct listing has not been used to raise fresh capital, likely due to regulatory concerns such as the lack of certainty surrounding the direct listing and “Gatekeeper concerns” (key participants in an IPO such as the underwriters are dubbed Gatekeepers, that is, entities that determine whether a company is worthy enough to go public)[4]. For instance, a company that decides to offer shares through a direct listing, may discover that the market valuation of its shares before the Direct Listing is unattractive and will decide to stop the process, therefore ruining contracts and transactions which are built on the success of the direct listing process. If a company and its shareholders stop the direct listing process, they face little or no backlash from the investing public and the regulators because it is not heavily publicized like an IPO, and the financial advisers are not held accountable for the direct listing failing or not kickstarting. Alternatively, if it is an IPO, and the company decides to pull the plug, they may face regulatory sanctions and the damage on the brand of the company may even be worse than the penalties incurred. The financial advisers and the underwriters will also not be left out as they risk being held liable for the failure of the IPO process.

Regardless of the concerns mentioned above, there are cogent reasons why tech companies and security regulators may consider direct listing as a viable alternative to an IPO.

Why a Direct Listing?

Price Discovery

In an IPO, underwriters usually confer with potential investors on the valuation of shares and based on such discussions, a price is set for the shares to be sold during the IPO. The valuation of such shares prior to the IPO, creates an illusion for the issuing company that their shares are highly priced. The company proceeds to make projections based on such valuations and are surprised by the market valuation of their shares a few days or weeks after the IPO. An example of this phenomenon can be seen with Jumia. Jumia priced its shares at $14.50 per share and as at April 2020, Jumia’s share price had crashed to $3 per share according to the New York Stock Exchange. Currently, Jumia’s share price has increased to $12.36 but it is still almost $2 below its original valuation[5].

This is why direct listings are considered favourable as the price of shares is determined by the buy and sell orders made by investors through the stock exchange. The price of the shares is discovered through a truly market-driven process and seems more efficient than an IPO and its “consulting process”[6]of pricing shares.

Liquidity

Existing shareholders who purchase shares during an IPO are usually restricted from selling their shares for a set period of time post listing, due to lock-up agreements. This is typically to ensure stability of shares of the company after the IPO and to aid the supply of shares to new investors as the company wants to ensure that every new share acquired is from the IPO and not existing shareholders.

A direct listing on the other hand, does not usually involve any lock-up stipulation. Therefore, there is liquidity for existing shareholders during the process of going public as the shareholders can sell their shares through the exchange.

Open Access

The type of investors involved in an IPO comprise of investors who receive an initial allocation of shares[7], and institutional investors. In addition, IPOs set a total maximum number of shares that are being offered to investors.

Meanwhile, in a direct listing, there is no fixed number of shares to be sold to the public and there is no set offering price on the shares. Investors will place their orders for the shares listed on the exchange for any price and size they believe is proper with their respective broker. This process will kickstart the price-setting process on the stock exchange. This open access to sell and buy shares created by a Direct Listing is an efficient way of pricing shares upon the open