As the IPO market wavers, direct listings and SPACs may be more attractive routes for startups looking to go public, some VCs say

  • As equity markets continues to teeter back and forth, some startups looking to go public are hoping to bypass the traditional IPO path.
  • Some VCs told Business Insider that more startups will be looking to go public through direct listings (like Spotify) or by merging with a SPAC (like Virgin Galactic)
  • Startups with enough cash in the bank and solid brand recognition could benefit from a direct listing.
  • But SPACs, also called blank-check companies, make more sense for startups that are not generating a ton of cash, but demonstrate a potential for high growth.
  • Visit Business Insider’s homepage for more stories.

The IPO jitters and delays began early this year due to the emerging coronavirus threat, before companies hoping to go public could have foreseen a fraction of the damage that the pandemic would later inflict on the economy.

Now with equity markets still roiling, companies fear that risk-averse investors will shy away from public offerings, or force them to make their public debuts at lower valuations than they’d hoped. The ongoing coronavirus pandemic has left the stock market in a state of uncertainty, with some experts saying that share values could fall up to 30%, as Business Insider’s Ben Winck has previously reported. 

Given the uncertain economic situation, it’s no surprise that startups and investors are growing wary of going public, at least in the traditional way. 

Rather than pursue the traditional IPO route, and the road-show fanfare that goes with it, startups and VCs are talking about 2 alternative paths: special purpose acquisition companies (SPACs) and direct listings.

Hims, a startup backed by Peter Thiel’s Founders Fund, is reportedly considering a deal with a SPAC, and Airbnb was reportedly approached by a SPAC interested in acquiring the beleaguered unicorn. 

Meanwhile, Palantir and Asana might follow in the footsteps of Slack and Spotify and file to go public via a rare direct listing.

Business Insider spoke with two VCs, Bullpen Capital’s Duncan Davidson and Sapphire Ventures President Jai Das, about why startups might be inclined to choose one IPO alternative over the other. 

Brand recognition: direct listings

In the days before the coronavirus pandemic, most companies looking to go public would participate in IPO roadshow to pitch their companies to potential investors and raise money. For many startups, the IPO roadshow is a way for them to put their names on the map, and get recognized by prominent investors, as Business Insider’s Allan Akhat and Jennifer Ortakales have previously reported. 

Now, “the IPO process is so constipated,” Davidson told Business Insider, referring to the slog of paperwork, requirements, and meetings that are required in the process. 

When Slack and Spotify decided to go public via direct listings, they skipped the in-person roadshow and opted instead for online meetings with investors who might buy shares from current shareholders. It seemed that enough prominent investors were already familiar with Slack and Spotify, so the banks didn’t need to market their shares as aggressively as they would a smaller, lesser known company, Davidson explained.

Unlike some startups, Slack and Spotify weren’t strapped for cash, so they didn’t need to sell new shares to raise money, which happens with traditional IPOs but is not currently permitted in a direct listing. When companies use that alternative, only existing shareholders can offer their shares on a public exchange, according to Business Insider’s Troy Wolverton.

On the flip side, Slack and Spotify didn’t need to pay as much money to the banks, who can take up to an 8% cut of the raised capital for their services to help pull off a traditional IPO, Davidson said.

Slack hired 10 banks to help with the the direct listing process, but 7 of those banks only assisted with providing research on Slack itself, as Business Insider’s Becky Peterson previously reported; only 3 helped with marketing. Spotify may have saved close to $100 million by opting for a direct listing, as Akhat and Ortakales have previously reported.

Hype: SPACs 

While startups taking the direct listing route must have their ducks in a row, companies looking to merge with SPACs can take a longer road to profitability. An important piece of the SPAC-profitability puzzle is hype, Davidson said.

SPACs might make more sense for startups that are not generating a ton of cash, but demonstrate a potential for high growth. But they’re also a good choice for industries that investors might see as taboo or disruptive, such as gambling, space travel, and cannabis

Insiders have been watching DraftKings, a sports betting platform that was acquired by a SPAC and went public in April. “A lot of investors won’t touch it because it’s gambling,” Davidson said. 

SPACs persuade investors to fund them for the purpose of acquiring another company with potential, and giving it a shortcut to the public markets, as Business Insider’s Mark Stenberg has previously reported.

Freshly funded SPACS themselves need to go through the usual IPO process to create a publicly traded “vehicle” for the companies that they later acquire. 

While SPACs can help get a startup to market more quickly, there are other risks involved, Das said in an interview with Business Insider. A blank-check company’s shareholders are free to stop a deal that they don’t like, potentially leaving a startup strapped for cash. Startups should also pay close attention to a SPAC manager’s track record, as well as the terms set out by the SPAC’s investors, before committing to a deal.

“You need to do your due diligence on the SPAC’s shareholders,” Das said. If shareholders aren’t excited about the SPAC’s deal, he explained, they can sell their shares right away, thus lowering a startup’s share prices and market cap.

But with the IPO process looking less and less attractive to startups, SPACs are generating serious momentum. 

This year alone, over 40 SPACs have filed to go public. SPACs have already raised over $20 billion this year, which is almost $6.7 billion more than SPACs raised in all of 2019. In particular, Bill Ackman and Chamath Palihapitiya‘s SPACs have generated some serious  buzz among insiders. 

Das said that while many private equity firms are fairly receptive to SPAC mergers, VCs are still debating.

“In 2015, 2016, SPACs were looked down upon,” Das said. But direct listings were once frowned upon, too, he added.

That is, until people watched Spotify make history by successfully bypassing the IPO process and going public at a $30 billion valuation.

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