IPOs, SPACs, and Direct Listings: Key Points for Investors

Most investors, at some point, dream of getting in on the ground floor of the Next Big Thing. Imagine, for example, if you had been one of the first people to buy Walmart stock upon its initial public offering in 1970. Or what if you had bought Apple at its initial offering price of $22 per share, in 1980? Of course, not all companies that make their stock available to the public enjoy the type of success that Walmart and Apple have, but successful offerings are the stuff of investing dreams.

There are basically three methods that companies use to sell their stock to the public: initial public offerings (IPOs), special-purpose acquisitions companies (SPACs), and direct listings. Though the end purpose of all three is the same—taking a company from private to public ownership by listing and selling stock on an exchange—the mechanics of each are slightly different. Here’s a quick explanation of the three procedures.

  1. IPOs. In an IPO, the key participants are the company making the offering and an underwriter (typically an investment bank) that purchases the stock in order to make it available to the public. The underwriter assists the issuing company with setting the initial offering price, managing regulatory issues, and, perhaps most importantly, with assessing the level of interest in the stock on the part of large investors such as mutual funds and other institutions. This part of the process is often called a “road show,” as the underwriter and company leaders travel to different parts of the country to make their presentations. The underwriter charges a fee for its services. The main safety feature of an IPO for the issuing company is that the underwriter typically guarantees the purchase of a certain number of shares or will offer to purchase any shares that remain unsold after the IPO. Most IPOs also feature a “lockup period”: a length of time after the IPO during which company insiders are not permitted to sell their stock. The expiration of a lockup period can generate a certain amount of volatility, based on market perceptions of company leadership’s willingness—or lack thereof—to maintain a significant share of ownership.
  1. SPACs. A special-purpose acquisition company—sometimes called a “blank check company”—is basically a corporate shell formed for the specific purpose of acquiring a private company and taking it public. SPACs are publicly traded, and once they acquire their target company, the target adds its value to the enterprise and, thus, its stock price. SPACs have been around for a while, but in 2020, they became very popular, raising some $150 billion in capital from January 2020 through March 2021—more than the total SPAC activity for the previous ten years. SPACs are registered with the SEC and publicly traded, even before they acquire a target company, so investors can buy and sell ownership units as they would with any other stock. Funds raised by a SPAC are held in trust until an acquisition is completed, and most SPACs have a time limit by which they must either complete an acquisition or return the funds raised to the shareholders. This also means that the time from formation to public trading is usually shorter for a SPAC than with an IPO.
  1. Direct listings. Companies that either want to save the cost of hiring an underwriter or that do not believe they require the services of an underwriter may register and sell their stock directly to the public, via a direct listing. Some companies choose this route because they want to avoid the dilution of issuing additional shares via an IPO. Others wish to avoid the lockup period typical of an IPO, giving them the ability to sell shares as soon as the listing is approved. Direct listings can be more volatile than IPOs, since there is no underwriter or other sponsor to support the initial stock price or purchase unsold shares. Recent examples of companies that utilized direct listings include Spotify, the music streaming service, and Slack, a popular online direct messaging service.

The key takeaway for investors who are interested in any of these types of offerings is that, no matter which vehicle a company chooses, once the stock becomes publicly traded, it is immediately subject to the same drivers of price as any other exchange-traded security. Pricing action may initially be influenced by such factors as lockup agreements, valuations of the underlying company, and other matters, but ultimately, the usual dimensions of expected returns—size, relative price, and profitability—will drive the future of the stock’s value.

I specialize in working with informed investors to create individualized plans for reaching their most important financial goals. Most critically, I am a fiduciary, which means that I am legally and ethically obligated to provide advice and recommendations that place my clients’ best interests before everything else. Click here to download my report, “The Fiduciary Standard and the Individual Investor,” to learn why it is critical to have a trusted advisor guiding your retirement strategy for 2021.

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