Alternative Paths to Going Public: SPACs and Direct Listings

The Traditional IPO: A Gated Entry to Public Markets

For decades, the Initial Public Offering (IPO) has been the canonical, well-trodden path for a private company to enter the public markets. This process is orchestrated by one or more investment banks that act as underwriters. They guide the company through rigorous regulatory filings with the Securities and Exchange Commission (SEC), determine an initial offering price based on extensive investor roadshows, purchase the shares from the company, and then sell them to their pre-vetted network of institutional investors. The company receives the capital raised, minus substantial underwriting fees, and begins its life as a publicly-traded entity. While this model provides certainty of capital raised and the expert guidance of seasoned underwriters, it is also often criticized for being lengthy, expensive, and opaque. The pricing mechanism can leave significant “money on the table” for the company if the stock pops dramatically on its first day of trading, a phenomenon that benefits the underwriters’ institutional clients rather than the company itself.

The SPAC Surge: A Backdoor to the Public Market

A Special Purpose Acquisition Company, or SPAC, represents a fundamentally different approach. Also known as a “blank check company,” a SPAC is itself a publicly-traded shell company with no commercial operations. Its sole purpose is to raise capital through an IPO with the express intention of acquiring or merging with a private operating company, thereby taking that company public. This process is often called a “de-SPAC” transaction.

The SPAC Lifecycle:

1. Formation and IPO: A SPAC is formed by a sponsor team, typically comprised of experienced executives, investors, or industry specialists. This sponsor team has a track record that lends credibility to the venture. The SPAC goes public itself, raising capital by offering units (typically consisting of one share and a fraction of a warrant) to investors. These funds are held in a trust account, earning interest until a acquisition target is found.
2. The Target Search: Following its IPO, the SPAC has a predefined window, usually 18 to 24 months, to identify and complete a merger with a private target company. If it fails to do so, the SPAC is liquidated, and the funds in the trust are returned to the investors.
3. The De-SPAC Merger: Once a target is identified, the SPAC negotiates a merger agreement. This deal is then presented to the SPAC’s shareholders for approval. Shareholders have the right to vote for or against the deal and, crucially, the right to redeem their shares for a pro-rata portion of the trust account’s cash if they disapprove of the merger. This redemption feature provides a layer of protection for initial investors.
4. Becoming a Public Company: Upon shareholder approval and the closing of the transaction, the target company assumes the SPAC’s stock ticker and listing, effectively becoming a public company without having gone through a traditional IPO.

Advantages of the SPAC Route:

• Speed and Certainty: The SPAC process can be significantly faster than a traditional IPO once a target is identified. The merger negotiation is a private transaction between the SPAC sponsor and the target company, bypassing the extensive roadshow and volatile pricing process of an IPO. This can provide more certainty regarding the valuation and the amount of capital that will be delivered to the company’s balance sheet.
• Forward-Looking Projections: Unlike in a traditional IPO, where discussing future financial projections is heavily restricted, a company merging with a SPAC can present detailed, forward-looking financial models to investors. This is a powerful tool for high-growth companies whose value is based on future potential rather than past performance.
• Operational Expertise: A high-quality SPAC sponsor can bring more than just capital. They often provide strategic guidance, industry connections, and operational expertise, acting as a partner to help navigate the transition to public life.

Disadvantages and Risks of SPACs:

• Dilution: SPAC structures introduce inherent dilution. Sponsors typically receive a “promote,” usually 20% of the equity in the SPAC, for a nominal price. This cost is borne by all shareholders post-merger. Warrants issued to initial investors can also create further dilution when exercised.
• Potential for Misaligned Incentives: The sponsor’s imperative to complete a deal within the limited timeframe could potentially lead to a merger with an inferior target company just to avoid liquidation. The sponsor’s promote creates a incentive to do any deal, not necessarily the best deal for shareholders.
• Regulatory Scrutiny: The SEC has significantly increased its scrutiny of SPACs, focusing on disclosure practices, liability concerns, and the accuracy of forward-looking projections. This has cooled the market from its peak and introduced more uncertainty into the process.
• Redemption Risk: High shareholder redemptions at the time of the merger can drastically reduce the amount of cash the target company ultimately receives, potentially undermining the primary goal of raising capital.

Direct Listings: A Pure Play for Going Public

A direct listing, or direct public offering (DPO), is a more recent and minimalist alternative that strips away the intermediaries entirely. In a direct listing, a company does not issue new shares or raise capital directly through the event itself. Instead, it simply lists its existing shares on a stock exchange, allowing them to be traded publicly for the first time. There is no underwriter, no roadshow, and no lock-up agreements for existing shareholders (unless they choose to impose their own).

The Mechanics of a Direct Listing:
The company works with financial advisors to file a registration statement with the SEC, much like in an IPO. However, instead of a fixed price being set by underwriters, the opening price on the first day of trading is determined by a auction conducted by the listing exchange (e.g., the NYSE). Supply and demand from buy and sell orders submitted by broker-dealers set the initial clearing price. This allows the market to discover the company’s value in a transparent, open process.

Advantages of Direct Listings:

• No Dilution from New Capital (Direct Listing without a Capital Raise): In its pure form, a direct listing does not create new shares, so there is no dilution for existing shareholders from the event itself.
• Cost Efficiency: By eliminating underwriting fees, which can typically range from 3.5% to 7% of capital raised, a company saves tens or even hundreds of millions of dollars.
• Market-Based Pricing: The auction process allows for a transparent price discovery mechanism. It avoids the potential for an IPO to be underpriced, ensuring that the value created on the first day of trading accrues to the company’s existing shareholders and employees who are selling, not to institutional investors flipping shares for a quick profit.
• Liquidity for Shareholders: It provides immediate and broad liquidity for existing shareholders, employees, and early investors without the typical lock-up periods associated with IPOs.

The Evolution: Direct Listings with a Capital Raise
Recognizing the limitation of not raising new capital, exchanges successfully petitioned the SEC to approve a new type of direct listing that allows a company to issue new shares in conjunction with its market debut. This hybrid model, known as a “direct listing with a capital raise,” combines the cost savings and market-based pricing of a direct listing with the ability to raise primary capital, making it a viable competitor to both traditional IPOs and SPACs for a broader range of companies.

Disadvantages and Challenges of Direct Listings:

• No Capital Raise (in traditional form): The classic direct listing does not provide the company with new capital, which is often a primary reason for going public.
• No Underwriter Support: The absence of an underwriter means there is no guaranteed base of investors to support the stock. The company bears the full risk of market demand and must market itself directly to investors, which can be challenging without an established market presence.
• Price Volatility: The lack of a stabilizing underwriter and the auction-based opening can lead to extreme volatility in the stock price during the first days and weeks of trading.
• Not Suitable for All: Direct listings are generally more suited to well-known consumer brands or companies with a large, diverse shareholder base that can generate sufficient trading volume and liquidity from day one. Lesser-known companies may struggle to attract enough investor attention without the backing of a major investment bank.

Key Considerations: Choosing the Right Path

The decision between a traditional IPO, a SPAC merger, or a direct listing is a complex strategic choice that depends on a company’s specific circumstances, goals, and risk tolerance.

• A Traditional IPO may be preferable for companies that value the guidance and market-making support of investment banks, need to raise a significant amount of primary capital, and desire the marketing “halo effect” of a well-executed roadshow. It is the path of greatest certainty in terms of capital raised but with higher costs and less control over initial pricing.
• A SPAC Merger can be an attractive option for companies operating in innovative or complex industries that are difficult to value through a traditional IPO process. It is ideal for those that want to tell a forward-looking story, value the operational expertise of a strong sponsor team, and prioritize speed and valuation certainty over potential sponsor dilution.
• A Direct Listing (especially with a capital raise) is best for mature, well-known companies with strong brand recognition and a large existing shareholder base. It is the path for those who want to minimize costs, avoid dilution from underwriting fees, embrace transparent market-based pricing, and provide immediate liquidity for their shareholders without lock-up restrictions.

The landscape of going public is no longer a one-way street. The emergence of SPACs and direct listings has democratized access to public markets, providing company founders and boards with powerful alternatives that offer different trade-offs between cost, control, speed, and certainty. This competition is forcing a modernization of the traditional IPO model itself, leading to a more dynamic and company-friendly ecosystem for entering the public markets.