These days startup companies are staying private longer as they are consistently raising more substantial amounts of capital through private funding. For the sustainable and enduring companies that choose alternative financing options, therein lies the public market. The public market, people like you and I, hold companies to a higher standard of accountability — for financial discipline, disclosure, meeting company goals, strategic direction, and even social responsibilities. While many companies choose to enter the public market through the traditional IPO process, some prefer the direct listing route. But what do IPOs and direct listings have to do with your employee shares? Everything.
Direct listings seem to be an emerging trend to enter the public markets as opposed to the traditional IPO process. If you haven’t heard the news as yet, Asana, a software startup focused on project management, is one of those few companies that opted for a direct listing. In doing so, Asana will be the 3rd recent company to choose this alternative route after Spotify and Slack.
As a startup employee with hopes of a successful exit, whether your company decides to do an IPO or direct listing makes a difference in your employee shares. Before we dive into the how, let’s first get into the basics of IPOs and direct listings and why they matter.
Initial Public Offerings (IPO)
When companies elect the IPO process, new shares are created, and there’s a ton that goes on behind the scene en route to the first trading day in the public market. For instance, in a traditional IPO, one or more investment banks serve as underwriters — financial experts who quarterback many aspects of the offering. Their role ranges from filing S-1 paperwork with the SEC to setting up roadshows, to garner interest from the investment community and raise capital. Believe it or not, but the investment banks also set the IPO price, buy shares from the company to sell to various institutional investors in their distribution network, who will then sell the shares to individual investors in the public market. In a sense, they provide a safeguard if the demand for the stock is weaker than expected.
Why do investment banks do all of this, you ask? Because they earn a percentage of how much the company raises from institutional investors during the IPO process. Go figure. Generally, on opening day, investors will keep an eye on the stock’s opening and closing price and compare it to the IPO price. Typically, it’s a good sign if the opening stock price is above the IPO price, but not too much higher as this could signal money left on the table due to a low IPO price target. In other words, the company could have sold the shares to investment banks at a higher price, resulting in raising more capital.
Direct Listings: An Alternative to IPO’s
As with most systems and industries, the legacy IPO process is also ripe for innovation. A direct listing is exactly as the name annotates: direct. Rather than creating new shares, employees and investors sell their existing shares directly to the public. Selling existing shares prevents the value of your employee shares from diluting when entering the public market. Unlike IPOs, direct listings have no intermediary underwriters or roadshows, and no setting a price range on the company’s stock — hence making the process faster and less costly.
This cost-efficient advantage comes at a cost to you and your employee shares because there is no support or guarantee of the share sale and potentially minimizes the number of long-term investors. The availability of shares is dependent upon early investors, such as yourself, while the price is purely dependent upon public market demand. As a result, there could be market swings and more volatility associated with the stock price.
The Lock-Up Period
Lastly, a significant impact of IPOs, direct listings, and your employee shares is in the lock-up period. In a traditional IPO, existing company shareholders agree to a period, usually 180 days from the date of the IPO pricing, where they are restricted from selling or hedging their shares. Although the SEC does not require lock-up periods, investment banks usually ask for this restriction because it allows for a set period for the company’s shares to trade and establishes a track record during the six-month window.
The direct listing process does not have a lock-up period. Since no new shares are issued, transactions will only occur if existing shareholders are seeking liquidity and choose to sell some or all of their shares.
The Demanding Public Markets
IPOs are unpredictable. Sometimes things work out the way we’d hoped and sometimes they don’t. As an investment advisor, I can tell you that the public markets will look for evidence of a strong, healthy, thriving startup — and superb growth and profitability are some of the best indicators of this.
It can be easy to become enthusiastic or even anxious about the possibility of your company successfully going through an IPO or direct listing. Not only may a successful entrance into the public market lead to increased liquidity for your employee shares, but an appreciation of the stock price might also lead to the generation of considerable wealth. The biggest mistakes I see made with equity compensation are getting caught up in the emotions of a liquidity event like an IPO or direct listing, and misunderstanding the technicalities to optimize stock decisions.
You Are The YOU Expert
As much credit as I like to give myself for establishing a niche and becoming an expert on equity compensation, you are the YOU expert. If you manage to amass a significant amount of wealth from the equity in your employer’s company, what would you do? Better yet, how would that make you feel? Would you do anything differently with your time? You may not have the answers now, but the best part is that you don’t have to figure it out on your own. That’s where a trusted financial planner comes into play, someone you can be vulnerable with — who you can share your goals, dreams, and ideas with.
Because of the unpredictability of life and the complexity of financial markets, it is imperative to work with an advisor who will help you to achieve your financial and life goals. Financial life planning is less about returns on investments, as it is about your values, priorities, circumstances, and aspirations — and designing your unique version of independence. You see, building a foundation is all in the intrinsic details. Be that as it may, personal values will drive behavior and help guide the decisions that we make. So I ask, when you achieve the financial freedom you’re working so hard towards, what are you going to do with it?