A large book titled “Recipes for Going Public,” a chef blowing a kiss, and a pot of dollar bills and unicorn horns.
A large book titled “Recipes for Going Public,” a chef blowing a kiss, and a pot of dollar bills and unicorn horns.

The New Rules of the IPO

Three Ways to Take Your Company Public Without a Traditional IPO

Dutch auctions? Reverse mergers? Direct listings? The pros and cons of IPO alternatives.

This story is part of The New Rules of the IPO, a multi-part special report.
Illustrations: James Clapham

AA graveyard of hyped unicorns has some companies canceling or postponing their IPOs and considering other alternatives for raising money and getting that coveted ticker symbol. Here are the other routes companies are taking to go public — and how they stack up to a traditional IPO.

IPO

First, let’s look at the Wall Street status quo. An IPO is how virtually every big publicly traded company gets on stock exchanges like the New York Stock Exchange (NYSE) and the National Association of Securities Dealers (Nasdaq). (Another stock exchange may be coming soon.)

The IPO has been around since the dawn of the stock markets, but after a peak of more than 300 IPOs a year in the ’90s, we’ve seen close to 100 IPOs per year, on average, over the past two decades. Part of that is due to regulatory changes that allowed companies to have a larger number of private shareholders (up to nearly 2,000) and privately raise larger rounds of capital (upwards of $500 million to $1 billion) without being forced to go public.

With an IPO, a company steps through a series of hoops that can last several months to years. A company typically hires an investment bank to guide it through the process, in exchange for a fee of about 4–7 percent of the money raised. That includes helping the company prepare an S-1 (a prospectus required by the SEC that provides a deep dive into the company’s financials, future plans, and its team) and lining up a one- to two-month-long roadshow to pitch investors on the company. Those investor meetings gauge investor demand and help bankers determine an offering share price.

Tradition also states that companies adhere to a “lockup” period of 90 to 180 days, depending on the agreement with investment bankers. That lockup period prevents employees and early investors from selling their shares before that time, giving confidence to new investors that this is indeed a good place to put their money.

The Upside

An IPO lets you raise capital by reaching a large number of investors. The money is typically available right away, doled out by the investment bank. There’s also the benefit of added publicity and attention from Wall Street analysts, which can generate demand for your company’s shares.

Downside

IPOs are expensive and time consuming. On average, companies spend $750,000 and 18 months preparing for an IPO. And there have long been complaints from companies about underpricing, when an underwriter prices shares too cheaply — leading to a big opening day pop but less money raised for the company.

An IPO gone awry also can tank your entire company. Just take a look at WeWork. The co-working company’s IPO imploded last year over media scrutiny of the business and its CEO Adam Neumann. The company, once valued at $47 billion, now has a valuation of about $5 billion, its CEO pushed out, and thousands of employees laid off.

Reverse Merger

Call it the sneaky way to become a public company. Essentially, a private company takes control and merges with a public company, often a dormant shell corporation that doesn’t have assets or real operations — but does have a ticker symbol.

Reverse mergers were popular 30 to 40 years ago, and hundreds of companies sought out “zombie” shells to trade on the public markets. In the 1980s, they were a favorite among small natural resource companies.

Over the past decade, the SEC has cracked down on the practice, after several reverse-merger companies — including some foreign firms that used the practice to enter U.S. markets — were accused of “pump and dump” schemes to scam investors. In 2011, the SEC issued a fraud warning, urging caution when investing in companies that went public through reverse mergers. Over the next few years, the agency suspended trading for more than 800 shell companies.

Nonetheless, there are legitimate companies that have gone public through the reverse-merger path, including Dell, which reentered the public markets this way in 2018 after going private in 2013. A handful of biotech companies have also recently used reverse mergers with other biotechs as a way to quickly enter the public markets. In 2018, Mereo BioPharma canceled its proposed $81 million IPO and instead closed a merger with a $207 million OncoMed Pharmaceuticals. Last year, NeuroBo Pharmaceuticals landed a Nasdaq listing via a reverse merger with Gemphire Therapeutics.

The Upside

A reverse merger has long been considered one of the most cost-effective and fastest ways to go public. (Think: one to four months for a reverse merger versus six to 12 months for an IPO.) Original investors can gain liquidity, and the company can raise new capital through a secondary offering.

The Downside

The reverse merger has gotten harder to pull off successfully. Unless the company meets stringent requirements, the NYSE and Nasdaq won’t even list surviving reverse merger companies for a minimum of one year after the merger. And without analyst attention and the publicity of an IPO, the stock may suffer.

You may also inherit problems if you’re not careful: Some shell companies may have liabilities such as litigation.

Dutch Auction

After a number of technology and Internet IPOs were dramatically underpriced in the late 1990s — not by just a little, but by as much as 1,000% — Dutch auctions seemed to offer CEOs the promise of going public without getting ripped off by their investment banks.

In a traditional Dutch auction, named for the flower markets of the Netherlands, the seller specifies the number of items for sale and then sets a minimum bid price. Bidders, then in turn, state how many items they’ll buy and the price they’ll pay. The winning bidders pay the same price per item, or the clearing price. In IPO terms, what that means is that instead of having investment bankers determine what investors might be willing to pay for a stock, the investors themselves decide what the firm is worth. Wow, what a concept.

Dutch auctions gained a lot of attention when Google used one to go public in 2004, but despite this, they never really took off as an alternative to a traditional IPO. Only a handful of companies, including Overstock, Morningstar, NetSuite, and Rackspace, have used them to go public. These days, Dutch auctions are primarily used when a public company buys back some of its shares.

The Upside

A Dutch auction lets the company get the going market rate for its shares, without worrying about an investment bank underpricing shares to get an opening day IPO “pop” that rewards the bank’s best customers.

The Downside

Some experts deem such auctions as risky, because there’s no telling how many people will buy shares, and there’s a lot more uncertainty about the stock price.

Perhaps the biggest problem? Wall Street doesn’t exactly like the Dutch auction. By going against the status quo on Wall Street, your company’s debut on the public markets might not be well received. There’s a rumor that institutional investors were pressured to lowball bids for Google’s debut. VCs claim that investment banks weren’t on board because if Dutch auctions were proved to be successful, they would take away much of the bank’s ability to determine pricing.

Direct Listing

The direct listing is the IPO alternative du jour. It lets you avoid many of the headaches of an IPO and go public without issuing new shares. Instead, you sell a small amount of existing shares direct to the public once listed on an exchange. Unlike an IPO, a company doesn’t raise new capital, but a lot of today’s tech startups are already well capitalized, thanks to the big dollars in private markets.

A number of investors, including venture capitalist Bill Gurley of Benchmark Capital, have become outspoken proponents of direct listings, because they see today’s investment banking models as inefficient and outdated. They want an efficient way for early investors to sell some of their stakes without padding the pockets of investment banks. Slack and Spotify both went public using direct listings, and Airbnb may be opting for that path, too.

With a direct listing, you still file the S-1 prospectus for investors like you do in an IPO, although you don’t necessarily need an investment bank to do underwriting or a traditional roadshow. Spotify, for instance, held just one “investor day” to educate prospective investors. Unlike an IPO, the share price isn’t set in advance and existing investors can sell shares directly to the public without the traditional lockup period.

The Upside

You can avoid paying big bucks to investment bankers for the IPO and instead pay financial advisory fees, which are usually a lot less. And no lockup period means early employees and investors can sell shares right away.

The Downside

Unless your company is already well known, it may be difficult to drum up investor interest without the help of the investment banks. You may also deal with extra scrutiny from the SEC, not yet accustomed to this nontraditional approach.

Plus, there’s a chance that the Wall Street analysts that work for the investment bankers won’t love your stock reflexively because you are not buying yourself cheerleaders like you do in an IPO.

This story is part of The New Rules of the IPO, a multi-part special report.

I write. Journalist and author of weird, but awesome young adult fiction. www.jenniferalsever.com www.trinityforestseries.com

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