Exploring the Changing Dynamics of Going Public: A Comparative Analysis of Traditional and Alternative IPO Methods

The landscape of IPOs and direct listings is rapidly evolving. While the traditional IPO process remains the standard, new alternatives such as direct listings, SPACs, and DLPOs are gaining popularity. Each of these alternatives offers unique advantages and challenges, and companies must carefully consider their options when deciding on a path to becoming a public company. As capital markets continue to evolve, we can expect to see even more innovation in the publicly traded spaces.

As the more traditional method, we have the standard IPO process. It involves a company working with an investment bank to underwrite the offering and issue shares to the public. The investment bank will typically act as an intermediary between the company and the public markets, managing the pricing, allocation, and marketing of the offering. While the traditional IPO process has been successful for many companies, it has come under criticism for being expensive, time-consuming, and inefficient.

As a result, we have seen the emergence of new alternatives to traditional IPOs. One of these alternatives is the direct listing, which has gained popularity [1] in recent years. In a direct listing, a company sells its shares directly to the public without the involvement of an underwriter. This means that the company does not need to pay fees to an investment bank [1], which can result in significant cost savings. Direct listings have been used by high-profile companies such as Spotify [2] and Slack [2].

Direct listings offer several advantages [3] over traditional IPOs, such as cost savings, transparency, and flexibility. However, they also come with some challenges, such as the lack of underwriter support, which can result in price volatility and uncertainty [3].

Another alternative to traditional IPOs is the Special Purpose Acquisition Company (SPAC) [4] process. In a SPAC, a company is formed specifically for the purpose of acquiring another company. The SPAC raises capital through an IPO and then uses the proceeds to acquire another company, which becomes a public company through the SPAC process. SPACs have gained popularity in recent years due to their ability to offer a faster and more cost-effective path for a company to be publicly traded.

As the most distinct method, we have the emerging trend of direct listings with a primary offering (DLPOs). DLPOs combine elements of both traditional IPOs and direct listings. In a DLPO [5], a company issues new shares to the public directly, while also allowing existing shareholders to sell their shares in the offering. This allows the company to raise capital while also providing liquidity to existing shareholders. DLPOs have been used by companies such as Roblox and Coinbase.

There are many reasons why the use of these alternative methods is becoming more popular. One of the primary reasons for this trend is the level of flexibility [7] and customization that these methods provide.

Another factor driving the popularity of alternative methods is changing market conditions and investor preferences. Investors are increasingly interested in companies that prioritize sustainability [8], social responsibility, and ethical practices, and alternative methods can help these companies access capital while staying true to their values. Additionally, there is growing interest in new technologies and industries that may not fit neatly into traditional IPO frameworks, and alternative methods can provide a way to bring these companies to public markets.

As we have observed, there is a noticeable trend towards the increasing use and popularity of these alternative methods in the market. Let's then focus on the number of companies that went public via SPACs over the years. This method of going public had the steepest and most volatile adoption rates, making it a good example to illustrate the point that companies choose the optimal method for going public, considering all of its options, its current situation and the prevailing market conditions.

Figure 1 clearly illustrates how the percentage of companies going public through SPAC has exponentially risen from 2016 to 2021. So, what caused this growing adoption? Several factors have contributed to this rise, such as low-interest rates and abundant liquidity, which have made it easier for SPAC sponsors to raise funds from investors. Additionally, the COVID-19 pandemic has driven companies to seek alternative ways to go public due to the volatility [11] and unpredictability of the stock market. Moreover, regulatory changes and developments have also played a role in the increase in SPACs. In 2018, the SEC issued new guidance that made it easier for companies to go public through SPACs. Additionally, in 2020, the SEC proposed new rules that would increase disclosure requirements for SPACs [12], which could make them more attractive to investors. Despite this, the number of companies going public via this method significantly declined in 2022. Globally, only 155 companies chose to do so [10], compared to 610 in the previous year. This was mainly due to a rise in interest rates [13] and increased volatility in financial markets, which led to increased redemptions.

So, what can we expect in 2023? As the global market has started to show signs of lower volatility and together with the general expectation that the interest rate hikes should be slowing down by the end of 2023, more favorable conditions seem to be set in place for the global IPO activities to regain greater momentum by the second half of 2023. With this increase in IPO activity, new trends are expected to emerge, making it challenging to predict the level of adoption for these alternative methods. However, it is important to notice that, for instance, according to the EY IPO Report, it is expected that the SPAC market returns to its normalized pre-2021 level.

With this example, it can be concluded that the IPO market is a dynamic and ever-changing environment that is greatly influenced by market conditions. Companies and investors strive to select the most suitable option for their needs based on current and projected market conditions.

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Footnotes

a.????An underwriter is a financial institution, typically an investment bank, that helps companies to go public by purchasing shares of the company and reselling them to the public. The underwriter acts as a middleman between the issuing company and the investing public, helping to set the initial price of the shares and ensuring that the shares are sold to investors.

b.????In the context of SPACs, redemptions refer to the situation when a large number of SPAC shareholders choose to redeem their shares for cash instead of participating in the merger or acquisition that the SPAC is proposing. When a SPAC is formed, it raises funds from investors through an initial public offering (IPO) and holds the proceeds in a trust account until it finds a suitable company to merge with or acquire. Once a target company is identified, the SPAC shareholders have the option to either participate in the merger or redeem their shares for cash, usually at the IPO price.

Tomás Mendes

March 27th 2023

References

[1]????Ritter, J. R. (2019). Direct listings: An alternative to the traditional IPO. Journal of Applied Corporate Finance

[2]????Cox, J. D., & Subramanian, G. (2019). Evolving perspectives on direct listings after Spotify and Slack. Harvard Law School Forum on Corporate Governance

[3]????Corporate Finance Institute. (2022). Direct listing: What is it and how does it work?

[4]????Investopedia. (2022). Special purpose acquisition company (SPAC) explained: Examples and Risks

[5]????Investopedia. (2021). IPO vs. direct listing: What's the difference?

[6]????Statista. (2022). Number of traditional and SPAC IPOs in the United States from 2016 to 2021

[7]????University of Miami Business Law Review. (2021, May 28). SPACs: An Increasingly Popular Alternative to Traditional IPOs

[8]????Inclusive ESG. (2022, March). How Green Companies Attract Investment with Environmental Initiatives

[9]????SP Global Market Intelligence. (2022, March 22). SPAC IPOs, deals fell in 2022

[10]?EY. (2022). Global IPO trends

[11]?Ning Zhang, Aiqun Wang. (2021) The impact of COVID-19 shocks on the volatility of stock markets in technologically advanced countries

[12]?Ballard Spahr LLP. (2022, April 20). SEC proposes new rules for Special Purpose Acquisition Companies. Ballard Spahr Insights & Events

[13]?The Economist. (2022, December 8). Rising interest rates and inflation have upended investing