Slack Technologies is going to directly list its shares for public trading on the New York Stock Exchange this summer. In doing so, Slack is following in the footsteps of Spotify Technology, which last year did a successful direct listing on the NYSE.
In a direct listing, a private company registers the shares of its existing holders so they can choose to sell their shares on a public trading market. By contrast, in an initial public offering, a public company registers its own shares and raises more capital by selling them to investors.
With Lyft LYFT, +1.48% , Uber Technologies, Pintrest PINS, +0.00% and other “unicorn” companies taking the traditional IPO route, Slack’s direct listing is admittedly unusual and unorthodox. Slack’s decision raises potential concerns about how its shares will be priced and traded after its listing becomes effective.
Yet a direct listing is a smart move for a “decacorn” like Slack — a unicorn valued above $10 billion — which has wide name recognition and plenty of cash on hand.
As explained below, a direct listing will be beneficial both for public investors and Slack, if Spotify’s example is an indication:
On April 3, 2018, Spotify SPOT, -1.23% was slated to begin trading with an initial reference price of $132.50 per share – which was based on private sales of Spotify earlier that year. Because demand was so strong, the stock opened at $165.90 per share and closed the first day at $149.01 per share.
During the first 30-, 60-, and 90 days of trading after April 3, 2018, the returns on Spotify’s shares were excellent — 7.36%, 18.10% and 20.48% respectively. The returns for Spotify substantially exceeded the returns of both the S&P 500 SPX, +0.00% and the NASDAQ COMP, -0.21% during these three time periods, as shown in the table below:
Price (at close)
Return
Date
SPOT
S&P 500
NASDAQ
SPOT
S&P 500
NASDAQ
4/3/2018
149.01
2614.45
6941.28
0
0
0
5/14/2018
159.97
2730.13
7411.32
7.36%
4.42%
6.77%
6/26/2018
175.98
2723.06
7561.63
18.10%
4.15%
8.94%
8/7/2018
179.52
2858.45
7883.66
20.48%
9.33%
13.58%
On the day Spotify’s shares were first listed, its trading was robust — with a volume exceeding 30 million shares. And its daily trading volume stayed strong over the next 90 days — averaging more than 2 million shares per day. During those 90 days, the trading volume of Spotify was much higher than that of two other technology unicorns that went public in the same month and listed on the New York Stock Exchange — Ceridian HCM Holding CDAY, +0.58% and Smartsheet SMAR, +1.52%
Since those two unicorns were much smaller than Spotify, we examined the market value of the trading volume for each of the three companies as a percentage of their market cap at that time. Based on that metric, the trading volume of Spotify was still significantly higher than that of Ceridian or Smartsheet during their initial 90 days of trading.
Moreover, in order to evaluate the transaction costs for Spotify during the 90 days after its direct listing, we compared its average bid-ask spread to those of Ceridian and Smartsheet during the 90 days after their IPOs. The average bid-ask spread for Spotify was approximately 10 basis points (calculated as a percentage of the midpoint point between its current bid and ask quotes) — much lower than the roughly 27 basis points for Ceridian and roughly 50 basis points for Smartsheet.
Thus, direct listings give public investors a chance to buy a stake in a successful startup like Spotify or Slack — as opposed to the select group of institutional investors who are invited to buy shares in a private offering by a unicorn. And the shares of directly listed companies — if they have well recognized names – can be easily traded by public investors at reasonable prices with reasonable liquidity.
By contrast, in the IPOs of hot technology companies like Lyft and Uber , most shares are allocated by the underwriters to large institutions. Retail investors generally are left to try to buy shares in the wake of the IPO — when the price of the company’s shares often takes a big jump.
Read: Here’s how a hot company can go public without an IPO
See also: Pinterest’s IPO filing: 5 things investors should know
A direct listing by Slack would be helpful not only to public investors but also to the principal players of the company as compared to other alternatives. Here’s how:
First, after a direct listing, key employees and early investors in Slack could immediately sell their shares in a public venue at a price set by supply and demand. Absent a direct listing, these employees and investors could sell their shares only in private venues, such as the Nasdaq Private Market. Although that market tries hard to match sellers of private shares with institutional buyers, those institutions typically insist on steep discounts from the latest valuation of a unicorn’s shares.
Second, if Slack chose to list on the New York Stock Exchange through an initial public offering, rather than a direct listing, its “affiliates” would be subject to a lock-up for the next 180 days. During that period, affiliates could not sell any shares outside of those registered in the public offering. For this purpose, affiliates would probably include directors, senior officers and key executives of Slack as well as early investors with substantial holdings of the company’s stock.
Third, the fees paid by Slack in a direct listing would be much lower than the expenses incurred by the company in an initial public offering. For example, the prospectus of Spotify mentioned fees of $35 million paid to its financial advisers. In an initial public offering of a unicorn, the expenses of the Wall Street underwriters and other professionals can easily exceed $100 million.
Of course, after a direct listing, Slack would become a public company, so it would be required to issue quarterly and annual reports to investors. Although most executives do not like dealing with the pressures from securities analysts to meet short-term financial targets, these pressures can be mitigated significantly if the founders of Slack retain their higher voting shares. After the direct listing of Spotify, its two founders continued to control 80% of its voting power despite owning just 21% of its shares.
In short, the direct listing of Slack is likely to be the second in an extended line of direct listings by unicorns with high brand recognition and without immediate cash needs. Airbnb is reportedly mulling a direct listing for its shares in 2020. Such direct listings will create attractive opportunities for individual investors hungry for the stocks of tech unicorns, while helping to preserve the historic role of the U.S. public equity markets in financing high-growth companies.
Robert C. Pozen is a senior lecturer at MIT Sloan School of Management and a senior fellow at the Brookings Institution. Kevin Downey, a MIT undergraduate, contributed to this report.
Read: As unicorn deals loom, IPO market has work to do to catch up with last year’s pace
