NYSE Proposes a Capital-Raising Option in Direct Listings
The following Commentary has been updated by a subsequent Alert.
The Situation: Direct listings, through which a company lists its shares on a national stock exchange without conducting a traditional initial public offering ("IPO"), have received significant attention from the media and market participants. However, current stock exchange rules impose significant conditions—among others, companies conducting a direct listing are not currently permitted to raise capital in connection with the listing and must have at least 400 shareholders prior to the listing.
The Result: The New York Stock Exchange ("NYSE") has proposed a rule change that would allow companies to raise capital in a direct listing and to provide, subject to satisfaction of additional valuation requirements, a 90-day grace period before the shareholder requirement must be satisfied. The proposal is subject to U.S. Securities and Exchange Commission ("SEC") approval before it can become effective.
Looking Ahead: If the SEC approves the NYSE's proposed rule change, two significant obstacles facing companies considering direct listings would be removed, and a greater number of companies are likely to consider this alternative option as a path to listing on the NYSE.
In February 2018, the SEC approved amendments to the NYSE listing requirements, which opened the door to direct listings for private companies whose shares did not actively trade in a private placement market. The following year, the SEC approved amendments to the listing requirements for the Nasdaq Global Select Market, which substantially aligned the requirements of these two key exchanges for direct listings. The amendments permitted such companies to list their common equity at the time that a registration statement filed solely for purposes of allowing existing shareholders to sell shares became effective, subject to the company obtaining an independent valuation of at least $250 million and otherwise meeting the relevant exchange's listing requirements.
Although the direct listing process contemplated by the current rules has only been used in a few instances, criticisms of the traditional IPO process and its pricing mechanisms have generated focus on direct listings and their perceived benefits. However, current direct listing rules impose hurdles that make direct listings impractical for many private companies. In particular, the current rules (i) do not permit the listing company to raise new capital—a condition that limited direct listings to cash-rich private companies not needing additional financing, and (ii) require the listing company to have 400 round lot shareholders prior to listing—a rare circumstance outside of the largest private companies. The NYSE's proposed listing requirement amendments would address these significant direct listing obstacles.
The NYSE's proposed amendments would remove these two key obstacles in certain circumstances by (i) allowing the listing company to sell, on its own behalf, newly issued shares in the opening auction on the first day of trading on the NYSE, and (ii) providing a 90-day grace period before the 400 shareholder requirement must be satisfied for:
- any direct listing that includes a primary capital raise in which (i) the company sells at least $250 million of its shares in the opening auction, or (ii) the aggregate market value of publicly held shares (generally, used to mean all outstanding shares, excluding those beneficially owned by directors, officers, and 10% holders) held prior to listing, taken together with the market value of the shares sold by the company in the opening auction, is at least $350 million; and
- any direct listing solely to permit sales by existing shareholders (i.e., with no capital raising by the company) in which the market value of publicly held shares held prior to listing is at least $350 million.
If the SEC approves the NYSE's rule change proposal, direct listings will become a more appealing and feasible alternative for a substantially broader group of private companies, and we expect that the overall number of direct listings will increase. However, the NYSE's proposed amendments do not address all of the limitations of a direct listing. Whether a direct listing or a traditional IPO process makes sense for a particular company will remain an important question, involving a nuanced evaluation of the tradeoffs, costs, and benefits of each approach. Among other things, a company weighing a direct listing against a traditional IPO will need to carefully evaluate the pricing mechanisms for newly issued shares under each model, as well as the potential impact of each approach on the company's post-transaction shareholder composition. In addition, the direct listing requirements adopted to date have been largely developed with a focus on domestic companies, and foreign private issuers considering a direct listing face additional complexities and uncertainties.
Any company interested in a national securities exchange listing should consult with legal counsel and investment banking advisors early in the planning stages to fully understand the available options and evaluate their advantages and disadvantages. While a traditional IPO is likely to remain the most effective option for the majority of private companies, the additional optionality provided by the proposed NYSE amendments is a welcome development.
Two Key Takeaways
- The NYSE's proposed amendments to its listing requirements remove significant obstacles from the direct listing process and, if approved, are likely to result in continued focus on direct listing as an option for companies considering an IPO.
- There are limitations to both direct listing and traditional IPO models, and companies will need to carefully evaluate which approach best serves the company's specific goals and needs. This is a nuanced and complex decision, which should be evaluated in consultation with legal counsel and investment banking advisors.
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