On August 26, the Securities and Exchange Commission approved rules proposed by the New York Stock Exchange (NYSE) to allow companies engaging in a direct listing to raise capital directly through the sale of primary shares upon the direct listing, in addition to, or instead of, facilitating sales of shares solely by existing shareholders.
Direct Listings Generally
A direct listing provides a path for a company to go public without engaging in a traditional initial public offering (IPO) process. Rather than hiring underwriters to sell shares to a group of investors, a direct listing allows a company to go public by facilitating the sale of shares directly into the market upon the effectiveness of a registration statement filed with the SEC. Because there is no underwritten offering, sales in a direct listing are not subject to underwriting fees and are not subject to certain other commercial arrangements, including a typical 180-day lock-up agreement. Because there is no lock-up in connection with a direct listing, existing shareholders are free to re-sell their shares upon a direct listing, providing immediate liquidity to shareholders. However, under the existing rules, direct listing could only be used for sales of shares by a company’s existing shareholders, while companies could not raise money for their own account by selling newly issued shares to the public in a direct offering, foregoing the capital raising benefit of traditional underwritten IPOs. While investment banks will assume a limited role advising companies in preparing for a direct listing, they do not take an active role in book-building, pricing or market stabilization.
Under the newly adopted rules, the NYSE now recognizes two types of direct listings: (1) “Selling Shareholder Direct Floor Listings” where a company lists shares on the NYSE in connection with the direct sale of shares by existing shareholders; and (2) “Primary Direct Floor Listings” where a company lists shares on the NYSE and sells shares itself in the opening auction on the first day of trading, either in addition to, or instead of, facilitating shares by selling shareholders. The NYSE has established certain heightened listing standards for direct listings, including a requirement for companies to have an aggregate market value of publicly held shares of at least $100 million, as opposed to $40 million in the case of a traditional underwritten initial public offering. The heighted standard is designed to ensure that companies engaging in a direct listing are of suitable size and there is sufficient liquidity in the stock for market trading.
Market interest in direct listings has grown in recent years. In 2018 Spotify Technology completed a direct listing on the NYSE. Slack completed its direct listing on the NYSE in 2019. The trend for technology companies has continued with Palantir Technologies disclosing plans for a direct listing on the NYSE in August 2020.
Selling Shareholder Direct Floor Listings
The listing standards for Selling Shareholder Direct Floor Listings are unchanged by the new rules. To qualify, a company must satisfy the above mentioned test demonstrating $100 million in aggregate market value of publicly held shares. Aggregate market value is determined based on a combination of both (1) an independent third-party valuation; and (2) the most recent trading price for the company’s shares on a trading system for unregistered securities. Where no such recent trading price exists, the NYSE will determine that the company has met the aggregate market value test if the company provides a third-party valuation evidencing a market value of publicly held shares of at least $250 million. Shares held by directors, officers or holders of 10 percent or more of the shares are excluded when calculating publicly held shares. Following implementation of a direct listing, existing shareholders may also sell shares in reliance on the safe harbor provided by Rule 144 under the Securities Act of 1933.
Primary Direct Floor Listings
Primary Direct Floor Listings are generally subject to the same listing standards as Selling Shareholder Direct Floor Listings. Under the new rules, a company will be deemed to have met the $100 million aggregate market value of publicly held shares test if it sells at least $100 million in market value of its shares in the opening auction on the first day of its trading on the NYSE. Alternatively, if it will sell less than $100 million in shares in the opening auction, the company will be deemed to have satisfied the test if the aggregate market value of the shares that it sells in the opening auction, together with the shares that are publicly held immediately prior to the listing, is at least $250 million. In this case, market value is to be calculated using a price per share equal to the lowest end of the price range established by the company in its SEC registration statement.
Companies engaging in either a Selling Shareholder Direct Floor Listing or a Primary Direct Floor Listing must satisfy all other applicable requirements of the NYSE, including the requirements to have at least 400 round lot shareholders, 1.1 million shares outstanding at the time of initial listing and a price per share of at least $4.00 at the time of initial listing and must satisfy the applicable financial standards for listing. While the NYSE had previously proposed to provide a 90-day grace period for compliance with the 400 round lot shareholder and 1.1 million shares outstanding requirements in connection with direct listings, that proposal was dropped in the final proposal approved by the SEC, meaning that existing distribution standards will continue to serve as a bar to a direct listing for some companies.
Issuer Direct Offering Order/Auction
In a Primary Direct Floor Listing, the listing company sells shares itself in an opening auction on the first day of trading. In order to implement this, the NYSE has established a new Issuer Direct Offering Order (IDO Order), which is used to effectuate the sale of company shares in the direct listing auction and establishes the rules and procedures for the opening auction.
In connection with a Primary Direct Floor Listing a company must enter into only one IDO Order, setting the IDO Order as the sole mechanism for the opening auction. The IDO Order must state a limit price for the shares to be sold, which must be equal the lowest price of the price range established by the company in its SEC registration statement, the order must be for the full number of shares offered by the company as set forth in the registration statement, the IDO Order may not be cancelled or modified and the IDO Order may only be executed in full in connection with the direct listing auction.
A direct listing auction may not proceed if the auction price is below the lowest price or above the highest price established by the company in its SEC registration statement. Further, a direct listing auction may not proceed if it is determined by the company’s designated market maker that there is insufficient buy interest to satisfy both the IDO Order and all better-priced sell orders. Where there is insufficient interest to buy and the shares cannot be priced, the auction will not proceed and the shares will not begin trading.
Pending Nasdaq Proposal
On August 24, the Nasdaq Stock Market (Nasdaq) filed a proposal with the SEC to allow for companies to sell primary shares in connection with a direct listing on Nasdaq. Like the NYSE, Nasdaq has historically only permitted direct listings that allow existing shareholders to sell shares pursuant to an effective registration statement, and following the direct listing, the Rule 144 safe harbor. The proposed new rule, similar to the NYSE rule, would allow companies to raise capital in connection with a direct listing. Interestingly, the proposed Nasdaq rule provides that for purposes of determining whether the applicable market value of publicly held shares has been satisfied, Nasdaq will value the company’s shares using a price per share equal to the price that is 20 percent below the lowest price in the price range established by the company in its SEC registration statement. Similarly, for purposes of the opening trade, the proposed rule requires that the price per share be at or above the price that is 20 percent below the lowest price of the price range established by the company in its registration statement.
The SEC’s release approving the NYSE rule is available here.
The proposed Nasdaq rule is available here.