One downside to private listing is that unlike an IPO, companies do not raise cash. What's more, investment banks have mostly an advisory role in a direct listing. They do not work to get potential stock investors comfortable with the company and its stock through a traditional roadshow. So in the event of a bump in the road, holders may not be as willing to hold on to the company's stock, industry executives say. That could lead to more volatility in the share price or the company's stock becoming thinly traded and illiquid.
The two latest direct listings were by private companies valued at more than $1 billion known as unicorns, Spotify Technology SA and Slack, which are very well-known global companies that didn't need the large cash infusion that an IPO usually brings, said Heather Gates, San Jose-based national managing director, emerging growth company practice at Deloitte & Touche LLP.
The two major benefits of a traditional IPO are a probable large cash infusion and the ability to educate the marketplace through analyst relationships and investment banks, Ms. Gates explained. Both were already very well-known companies: Spotify as a global company and Slack in the business community, she said. And both Spotify and Slack "had large coffers of cash," she said.
"It's a rare circumstance that a company has so much money it doesn't need to raise more capital," and is so renowned that company executives can skip the investment banking process that connects the company to potential stockholders, Ms. Gates said.
Another benefit of direct listing is that shareholders can sell their shares immediately at a lower cost, Nixon Peabody's Mr. Partigan said. Typically, in a traditional IPO there is a lockup period prohibiting shareholder sales — about 180 days — to stabilize the market price, he said.
"The cost of a direct listing is minuscule compared to an IPO because you don't have the same underwriting spreads," he added. "Wall Street does not want them to use this alternative."
For example, the bankers who advised Spotify on its direct listing earned 0.5% of the value of the shares sold to the public compared to the 4% to 7% of the shares sold in a typical IPO, he said.
Another plus of a direct listing highlighted by Spotify's CEO Daniel Ek is the lack of dilution. "Spotify is not selling any shares. There is no underwritten offering and there are no underwriters," Mr. Ek said in a video posted on Spotify's website. "Why? Because there's no reason to dilute our existing shareholders to raise money we don't need."
It is hard to know how many companies are in the pipeline because direct listings start with a confidential filing, Mr. Partigan said. He had several clients that expressed interest after the NYSE last year adjusted a listing rule, but none have yet decided to go forward with a direct listing or an IPO or stay private.
Dubbed the Spotify rule, effective on Feb. 2, 2018, the NYSE has the discretion to approve the listing of a company even if it does not have a history of trading in a private placement market. In order to qualify for a direct listing, the company must provide an independent third-party valuation showing a market value of shares held by non-affiliates of at least $250 million.
Before the rule change, company shares needed to be traded in a private placement market, Mr. Partigan said.
"The kind of company that this would make sense for is a large private company that has access to sufficient capital in the private equity markets (and doesn't need) to raise capital on the public markets," Mr. Partigan said.
Direct listings have been around for a while. Only five or six obscure companies have used the process, he said. "I'm skeptical that this would be a common approach to liquidity," he said.
But it's too soon to tell. Mr. Partigan said if the stock prices of the unicorns that have directly listed perform well after a year of their debut, other companies could choose to go that route as well. And if smaller companies — those with valuations of less than $1 billion — successfully take advantage of a direct listing, that also could drive interest, he added.
Moreover, while companies that take the direct listing route do not raise capital at the time, they can later sell shares or issue debt on the public markets.
But that is not ideal, one observer said.
"It's not an efficient way to raise capital," said James D. Rosener, a partner in the commercial department of law firm Pepper Hamilton LLP who assisted a subsidiary of a foreign company with a direct listing. Once the company is public, registered with the SEC and has issued periodic public reports for a more than a year, it can issue shares and debt securities, he said.
"An IPO is not just a strategy to go public ... it's a capital-raising vehicle," Mr. Rosener said.
The market is more used to a traditional IPO, with controls including audits from accounting firms and investment bankers with the ability to buy and sell shares to stabilize the stock, at least in its first 30 days, he said.
"I just think the whole structure and ecosystem of a public offering … is what the market is ready for," Mr. Rosener said. "That's not to say that will never change." So far, Mr. Rosener said he has not seen a strong pipeline of potential direct listings.
