Differences Between IPO & Direct Listing

A company can barely grow without raising enough funds at the appropriate times. But choosing the right strategy is also crucial. Today we see a lot of private companies going public.

Two major routes to shift from a private company to a public one are issuing shares for the first time (Initial Public Offering) and Direct listing. While each strategy helps companies to go public, both of them differ from each other on several grounds. Be it objectives, lock-in period, research or cost involved. 

Today, in this guide, we will learn about each of them in detail. Also, we'll cover the differences and that too point-wise. So, keep reading till the end. 

Meaning of Direct Listing 

Direct listing refers to the way by which companies can raise funds from the public or shift to a public company by offering the existing shares to the public. Since the shares issued are not new, there is no need to hire an underwriter or promoter. A few major features of direct listing are that the process needs little regulatory necessities, eliminates the need for an underwriter, is time-saving, and offers only a limited number of shares during listing compared to an IPO. 

In DLP, the existing shares of existing private shareholders are listed on the stock exchange directly to be traded freely. But in DLP, the underwriter does not decide the price of the shares listed. Rather the price is decided by market forces. 

Benefits of the direct listing process 

• Money-saving: DLP is a money-saving process as the need for an underwriter is limited/eliminated. 
• Time-saving process: The direct listing process is comparatively faster than the IPO as it requires a few regulatory formalities.
• Less/Nil Fee: Companies don't have to pay fees which they are liable to pay as in the case of a traditional IPO since no additional capital is being raised through the direct listing. Compared to a 6-7% fee in traditional stock issuing, it is only 1-2% in DLP.
• Nil lock-up period: In traditional issuing, there is a certain lock-up period wherein insiders, and prominent shareholders are not allowed to withdraw or sell their investments. However, there is no such case in the DL method. Shareholders don't have to wait for a certain period to sell off their investments. 

Disadvantages of the procedure:

• Can be Highly volatile: Usually, the DL method is considered to be highly volatile because the price discovery process is eliminated. While as we see in the book-building process, various investors select prices based on the worth of the company. 
• No new capital: DL procedure does not lead to raising any additional money, which can be done through the issue of new shares. However, companies doing this have different goals. 

IPO meaning in the share market

It is a process through which a company which was bootstrapped before tries to raise capital by issuing shares for the first time in the primary market. 

The process signifies that a private company will not be private anymore. Its shares will be traded freely in the market after the stock exchange listing. It may be a time-consuming and expensive process, but it is one of the ideal and widely adopted ways to raise additional capital by most companies. 

Pros of the process:

• Raising funds: It is one of the ideal and widely adopted ways to raise additional funds for companies. If not Initial Public Offering, it is tough for companies to raise such a high amount of funds. 
• Incredible credibility: The process leads to greater credibility and visibility for companies as they have to be transparent about certain things. SEBI asks for certain reports occasionally, thus giving businesses an insight into what they are doing.

Cons of the process: 

• High Initial Costs: The process is very costly compared to DLP. This is because it involves various regulatory obligations such as hiring an underwriter, advertiser, investment bank, etc.
• High pressure: When companies raise funds from the public, there is pressure to serve investors with better value. The administrators of the company may refrain from taking risky decisions as they may impact the stock's price. 
• Higher Obligations: SEBI has made it mandatory for public companies to submit their financial data periodically. Hence, preparing and auditing the data requires time and money. 

Direct Listing Vs IPO

Let's learn about the key differences between the two. 

Goals

Each of the strategies is opted for with different objectives in mind. Startups/companies usually prefer IPO because they need additional capital. However, the DL process is different. Here companies do not wish to raise new capital. However, they wish to enjoy other benefits of going public such as greater liquidity for current shareholders, more visibility, recognition etc.

Costs

The direct listing method is relatively cheaper than the initial offering one. In traditional IPO, companies have to incur hefty costs to pay underwriters, advertisers and investment banks. However, there is no such need for the DL strategy as stocks from existing shareholders are directly sold to the public.

Research 

For DL, companies must look for external help to support them in research and stuff. But since companies opting for IP Offerings hire underwriters, they get additional marketing assistance, thus helping them boost stock sales. 

Lock-in period

The direct listing does not have any lock-in period meaning shareholders are free to sell their shares. However, in traditional stock launches, shareholders are not allowed to sell shares for a certain period as it prevents the market from becoming oversaturated. When the market becomes oversaturated, stock prices tend to fall. 

Final words

Direct listing and stock offering are the two ways private companies can turn into public enterprises. But both strategies are significantly different from each other in terms of objectives, costs, lock-in period and more. But as an investor, you must focus on other crucial things, such as the prospectus, checking risk factors and other documents. 

Frequently Asked Questions (FAQs):

Q. Does DL's strategy lead to raising additional capital?

No. The DL strategy does not lead to raising additional capital for companies. It is a way to go public for various other reasons. 

Q. Why do companies choose DL?

It is clear that companies choosing DL do not intend to raise additional capital. Instead, they focus on other benefits such as boosting liquidity for existing shareholders, gaining recognition, and improvising visibility into their business. 

Q. Why do companies opt for Initial Public Offering?

The main goals are to raise funds and improve the public profile of the company.