Editor’s Note: The nuances of an IPO vs DPO were first covered for students of the Intelligent Investor’s Immersive. You can find more details regarding the course here.
The tech companies are known for disruptions.
Now they even want to break the business of Initial Public Offerings (IPOs), changing the dominant way of listing companies .
There’s a rivalry between the west’s Silicon Valley t-shirt donning tech geeks and the east’s New York city power suit donning greedy bankers. It has been a bankers’ world for the past decades until tech became the key driver of the global economy.
Traditionally, a company that wants to go public gets a bank or two to get together and help them underwrite the process. In exchange, the fees for Initial Public Offerings can come up to 4-7% of gross proceeds arising from the offering. So the bigger the offering to the public and the better the sales and receptions, the more fees the bankers earn.
That dynamic has now changed.
Tech companies are now opting to cut out the middle men by using an alternative known as Direct Public Offerings (DPOs).
Spotify wasn’t the first company to do so.
According to Investopedia, the now-famous Ben & Jerry’s Ice Cream was one of the earliest to tap on this avenue of listing in 1984. However, none of the DPO precedents were as famous or as big as Spotify to garner the public’s attention.
“The US initial public offering market is broken. Try a direct listing, like we did at Spotify.”
Barry McCarthy, Spotify CFO
Spotify gave a reference price of US$132 and listed on New York Stock Exchange on 3 Apr 2018. The opening price was US$166.92, about 26% higher than the reference price.
What are the differences between IPO and DPO?
We have already discussed about the absence of a middleman and cost savings with an DPO. But there are more differences to highlight.
A typical IPO involves a massive creation of new shares to be sold to the investors. The cash paid by the investors would be injected into the company. The company would usually earmark the IPO proceeds for growth projects.
But a DPO on the other hand do not issue new shares but allow existing shareholders to sell their shares to the public. This means that the shares and cash would exchange hands directly between the buyers and sellers. The company wouldn’t get a single cent from these transactions.
Therefore, a DPO is NOT a fund raising event.
For this to work, DPO must allow the existing shareholders, including the insiders, to sell their shares. This is opposite to an IPO whereby insiders have to observe a moratorium period and are barred to sell their shares.
The advantage of the DPO over IPO in this aspect is that the prices are more transparent as it is determined by the market rather than the fixed underwritten IPO price.
Below is a table illustrating the differences.
| IPO | DPO | |
| Underwriting | Financial institutions | Companies themselves |
| Costs | More expensive | Cheaper |
| Number of shares | Increase | Same |
| Who gets the money | Cash goes into the company | Cash goes to the sellers |
| Lock-up period | Yes. Insiders are barred from selling over a certain period. | No. Insiders can sell. |
| Price discovery | Weak. IPO price only | Strong. Sellers and buyers have to agree to transact. |
Is DPO better than IPO?
Spotify advocates transparency and it was one of the main selling points the company reasoned for a DPO over an IPO, apart from the cost-saving.
While I agree that it is fairer to have a market-determined price, I just find that it uncomfortable allowing the insiders to cash out once the company goes public. There’s a conflict of interest if the insiders sell everything and there’s no longer any skin in the game in the company.
Also, the company doesn’t raise any cash to benefit from the exercise so as to get capital to grow the business further. It became merely a way to make the company shares more liquid on a public market and for shareholders to sell and new investors to come in.
I personally would prefer a middle-ground, sort of a hybrid DPO-IPO. DPO should create new shares and apply the moratorium for insiders. Only the new shares can be sold during the moratorium period.
Hence I see merits and pitfalls in either DPO and IPO avenues. I’m not hopeful about a hybrid that takes the best of both worlds would ever happen. Investors should therefore stay sceptical and evaluate each DPO or IPO on a case-by-case basis.
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