Every week, you see numerous companies or fund houses launching their NFOs and IPOs to raise funds. You apply to the IPOs, and after successful IPO allotment status, you get the shares that may list at a premium or discount.
However, what if the main motive of a company is not to raise funds, but it still wants to go public and list its shares on the stock exchange? This happens when a company does not issue new shares but wants to ensure that the current private shareholders cash in on the enterprise value by offering their shares to the general public.
Let us understand it better by learning about direct listing meaning.
What is direct listing?
Direct listing meaning refers to a process followed by companies to list their existing shares on the stock exchanges directly. In a direct listing, a company directly offers the existing shares held by company owners, employees, private investors, etc., to the general public without issuing any new shares. Since no new shares are issued, there is no need to hire underwriters who manage the issue of fresh shares during an IPO.
Direct listing is not similar to an Initial Public Offering (IPO), as companies do not have to issue fresh shares. Furthermore, direct listing warrants minimal regulatory compliance by the Securities and Exchange Board of India (SEBI). SEBI requires the companies to hire an investment bank to set a price for the shares (price discovery) and handle law compliance, investor communication, and regulatory filings.
How does direct listing works?
Direct listing allows companies to list their shares on the stock exchanges without launching a full-fledged IPO. The IPO process includes numerous steps, such as marketing, hiring underwriters, etc., which can cost companies a hefty amount. Hence, when companies plan to offer no new shares but sell their privately held existing shares, they avoid an IPO and choose direct listing. It helps significantly cut down the costs involved and helps companies provide an exit to current investors.
However, a company looking to list its shares directly without an IPO must fulfil certain benchmarks. Since companies looking for direct listing do not have to file a Draft Red Herring Prospectus (DRHP) that provides all the information about the company’s business, they must have a simple business structure. Furthermore, the company must have a high goodwill and brand value and a straightforward revenue model to ensure that investors can analyse the company’s financials, the industry of operation, competitors, and the risk factors without a DRHP.
Benefits of direct listing
Now that you have understood what direct listing is, here are the benefits of direct listing in India:
- Exit route: Direct listing provides an exit route to the existing shareholders. For example, a private company may offer shares to its employees through an Employee Stock Ownership Plan (ESOP). Direct listing ensures that the employees can sell their shares and realise the sale proceeds.
- Low-cost: Unlike an IPO, direct listing involves significantly lower costs as companies do not have to hire underwriters or file a DRHP with SEBI.
- Regulations: Direct listing is subject to comparatively lower scrutiny than an IPO. Companies only have to hire an investment banker and can list their shares without having to go through the comprehensive steps involved in an IPO.
Direct listing examples
Example #1
Company XYZ has a straightforward business model and wants to have more business visibility. However, it does not have enough capital to cover the expenses of an IPO. Hence, it hires an investment banker and lists its shares directly on the stock exchanges.
Example #2
Company ABC launched an internal ESOP to reward its employees by offering them company shares. After the vesting period (the date when employees can purchase the offered shares) is over, the company decides to go public. However, it chooses the direct listing route to provide higher liquidity to the employees and reduce the costs involved. Once the direct listing is completed, employees can sell their shares and receive the proceeds.
Direct listing vs IPO
Here are some of the major differences between a direct listing and an IPO:
- Goals: The main goal for a company to launch an IPO is to raise additional funds for business purposes. However, fundraising is not the main goal for a company taking the direct listing route. Companies opt for a direct listing to offer current shareholders an exit route and increase their business’s visibility.
- Costs: The direct listing method is comparatively cheaper than listing the shares through an IPO. Unlike an IPO, direct listing doesn’t require paying hefty amounts to advertisers and underwriters, which can save a company a lot of money.
- Lock-in period: Shares listed through an IPO have a lock-in period where investors cannot sell the shares bought for a specific period to avoid a drastic price fall. However, there is no such lock-in period for directly listed shares, and the shareholders can sell their shares whenever they want.
Conclusion
A direct listing is an ideal way for companies whose main motive is not to raise funds but to offer existing shares to the general public and offer an exit route to private shareholders. The process allows companies to reduce costs included in going public significantly without much regulatory compliance. Now that you know the direct listing meaning, you can better analyse a company if it takes the direct listing route.
