Direct Listing

What is a direct listing?

Direct Listing (also known as direct quotation or pure listing) is the admission of a company's already issued shares to exchange trading without new shares being sold to investors at the same time. There is no banking syndicate that takes up shares and sells them to investors through an order book (bookbuilding). The first price is formed on the exchange from the buy and sell orders that are in place when trading begins.

A direct listing is a variant of the stock market flotation alongside the classic IPO. It gives the existing shareholders a market for their shares but, as a rule, does not provide the company with any capital. The procedure became known mainly through listings on the US market. In Germany, admission without an offering occurs mainly where a broad shareholder base already exists, for example in the stock market listing of a spun-off group company.

Legal framework for a direct listing in Germany

The same basic requirements apply to a direct quotation as to any stock market flotation. The company must be an AG (German stock corporation), a KGaA (German partnership limited by shares) or an SE (European public limited company); a GmbH (German limited liability company) changes its legal form beforehand. The issuer applies for admission to the regulated market together with a credit institution or securities firm. Even without a public offering, a securities prospectus is in principle required for this, which the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) approves. The EU Prospectus Regulation ties the prospectus requirement to two events: the public offering and the admission to trading on a regulated market (which the German text of the regulation calls “geregelter Markt”).

Inclusion in the open market (Freiverkehr), which is organised by the exchange under private law, is also possible. Without a public offering, the prospectus requirement does not apply there; the exchange requires its own documents depending on the segment. After trading begins, the company is subject to the obligations of its market segment, which in the regulated market means the same reporting, disclosure and notification obligations as after a classic stock market flotation. The insider rules of the EU Market Abuse Regulation also apply in the open market if the company has applied for or approved the inclusion.

Price formation in a direct listing: opening auction instead of bookbuilding

In a classic stock market flotation, the company and the banks set the placement price on the basis of an order book. In a direct listing, the first price arises in an opening auction in which the exchange brings together all buy and sell orders in place. A reference or guidance price published in advance can give pointers, but it is not binding. Sell orders come exclusively from existing shareholders, that is, the current holders of shares. Buy orders come from investors who know the company from the prospectus, their own analysis and information events that take the place of a classic roadshow.

Three elements of the classic procedure are therefore missing. Banks do not take up shares, they do not support the price after trading begins through an over-allotment option (greenshoe), and there are no contractual lock-up periods, which banks otherwise require from the existing shareholders. Liquidity in ongoing trading is provided by liquidity providers, that is, securities firms that continuously quote binding buy and sell prices. In the electronic trading system Xetra, they are called designated sponsors. In the US market, the New York Stock Exchange and Nasdaq now also permit variants in which the company sells new shares in the opening auction.

Advantages, disadvantages and suitability of a direct listing

The advantages are considered to be lower transaction costs, because no underwriting commission is paid to the banks, and the absence of dilution for the existing shareholders, whose stake would otherwise fall because of new shares. Price formation also plays a part: in a classic stock market flotation, the placement price is often deliberately set somewhat below the expected market price so that the offering is fully subscribed. This discount does not exist in a direct listing. Advisory banks, law firms and auditors are nevertheless needed, and the effort for the prospectus and capital market readiness remains almost the same.

Against this stand disadvantages: the company generally receives no capital, and without banks nobody supports the price after trading begins. A direct listing is therefore suitable for companies that need no new capital, already have a sufficiently broad shareholder base and are known to investors. Without a free float, that is, without shares in the hands of many investors, no liquid trading takes place, and without name recognition demand is lacking. Growth companies with a capital requirement almost always choose the classic stock market flotation with a capital increase. Raising capital through the exchange later remains possible after a direct listing.

Worked example: opening price in a direct listing

An AG with 40 million shares has its shares admitted to trading without an offering. For the opening auction, the following orders are in place, in simplified form. Sell orders from existing shareholders: 200,000 shares from EUR 10, 300,000 shares from EUR 11, 250,000 shares from EUR 12. Buy orders: 150,000 shares up to EUR 13, 250,000 up to EUR 12, 300,000 up to EUR 11, 200,000 up to EUR 10. In simplified terms, the price at which the largest volume can be executed applies.

• At EUR 10: supply 200,000, demand 900,000, executable 200,000 shares
• At EUR 11: supply 500,000, demand 700,000, executable 500,000 shares
• At EUR 12: supply 750,000, demand 400,000, executable 400,000 shares
• At EUR 13: supply 750,000, demand 150,000, executable 150,000 shares
• Opening price: EUR 11 with 500,000 shares traded, turnover EUR 5.5 million
• Market capitalisation: 40 million shares × EUR 11 = EUR 440 million
• Inflow of funds to the company: EUR 0, the turnover goes entirely to the selling existing shareholders

At EUR 11, buy orders for 200,000 shares remain unexecuted. This surplus of demand can push the price up in continuous trading. Conversely, additional sell orders would put pressure directly on the price without support from banks. The ratio is noteworthy: in the auction, only 500,000 of 40 million shares change hands, that is, 1.25%. The price formed in this way nevertheless values the entire company. The fewer shares are traded, the more the valuation depends on a few orders.

Distinctions: direct listing, IPO, SPAC, spin-off and secondary sale

• IPO: public offering with bookbuilding, usually combined with a capital increase. Banks take up and place the shares, stabilise the price and agree lock-up periods.
• SPAC: a shell company without a business of its own (Special Purpose Acquisition Company) raises capital through its own stock market flotation and then acquires an unlisted company, which thereby reaches the stock market. Unlike in a direct listing, the target company generally receives capital in the process.
• Spin-off: separation of part of a business into a company of its own. Its shares are often admitted without an offering because the shareholders of the parent company already hold them.
• Secondary Sale: sale of existing shares to selected investors outside the exchange. Here too, no capital flows to the company, and no admission is required.

Common mistakes

• Free float overestimated. If the founders and a few investors hold almost all of the shares, no liquid trading arises after admission.
• Capital requirement overlooked. The procedure generally brings no capital. Companies that still have to finance their growth lose time until the next capital measure.
• Marketing neglected. Without information events for investors, analyst reports and a comprehensible equity story, there are no informed buyers when trading begins.
• Selling pressure not managed. Without contractual lock-up periods, many existing shareholders can sell at the same time and put pressure on the price.
• Effort underestimated. The prospectus, change of legal form and ongoing obligations largely correspond to those of a classic stock market flotation; what is mainly saved is the underwriting commission.

Frequently asked questions

What is the difference between a direct listing and an IPO?

In an IPO, banks place shares with investors; in a direct listing, existing shares are merely admitted to trading. The IPO price arises in bookbuilding, the first price of a direct listing in the opening auction. Underwriting by banks, price stabilisation and contractual lock-up periods exist only in an IPO, and as a rule so does the inflow of capital.

Does the company receive capital in a direct listing?

As a rule, no. Only existing shares become tradable; the proceeds from sales go to the existing shareholders.

Is a prospectus needed for a direct listing?

For admission to the regulated market, in principle yes, even without a public offering. For inclusion in the open market without an offering there is no prospectus requirement, but the exchange sets its own requirements.

Do lock-up periods apply in a direct listing?

Not automatically. In a classic stock market flotation, lock-up periods arise from the contract with the banks. In a direct listing, existing shareholders can agree them among themselves, but they are not obliged to.

Who sets the first price?

Nobody sets it; it results in the opening auction from the orders in place. A published reference price serves only as guidance.

The Roemer Capital view

The technology companies in Series A to C that Roemer Capital supports are mainly looking for capital. A procedure that brings none rarely fits this phase. If founders or early investors nevertheless seek liquidity, Roemer Capital first examines the obvious routes. Candidates are a secondary component within the funding round, in which new investors additionally take over existing shares, or a partial sale to a single investor.

In a sale process, Roemer Capital classifies exchange variants soberly. What matters is whether the shareholder base is broad enough and the equity story known enough for a sustainable price to form without placement.