What is a DPO? Taking a direct approach to the public markets

Open full sized image

The starting line of life as a public company.

© Tobias Titz—fStop/Getty Images

Initial public offerings, or IPOs, are a well-traveled road that many companies use to sell shares to the public for the first time. But shorter paths exist, including the direct public offering (DPO), also known as a direct listing. This is when a company puts shares directly onto a stock exchange without all the steps required for an IPO.

DPOs are a relatively new phenomenon that offers certain advantages for companies, including a chance to save money going public (or putting shares on a stock exchange). But these vehicles also pose unique risks for investors compared to traditional IPOs because they provide less information about the company’s finances and present the chance for more volatile trading.

To understand the difference between IPOs and DPOs, think of the company going public as you would a farmer selling their harvest. The farmer could approach a big food processor or a supermarket chain to help get their product to market. Or they could bypass the middlemen, belly up to a booth at the local farmer’s market, and hawk their sweet corn, almonds, or peaches directly to the public.

DPOs are more like the farmer’s market, allowing companies to sell shares to investors on the stock market while bypassing the often lengthy and complicated IPO process. It skips IPO steps like going on the road to educate possible investors about the company’s products and plans, getting buy-in from major Wall Street banks, and offering a full suite of financial data to the public.

A DPO lets a private company become public, typically without raising new funds, by selling shares directly to the public on an exchange. Unlike IPOs, DPOs aren’t backed by underwriters or other intermediaries, which are often big Wall Street banks.

DPOs date as far back as the 1980s, but they gained popularity in 2020 when the U.S. Securities and Exchange Commission (SEC) gave the New York Stock Exchange (NYSE) approval for direct listings. The SEC also approved DPO listings on the Nasdaq exchange. An SEC approval is still necessary for a DPO, and companies need to register with the agency.

DPOs are priced based on an auction process similar to an IPO. The day before trading begins, the exchange posts a “reference” price, which is based on the company’s public financial information, previous private market valuations, and the value of the company’s public competitors. On the first day of trading, the auction begins and the price can change depending on demand and other factors.

A company that’s going public typically has existing shareholders, including founders, employees, and early-stage investors. Both an IPO and a direct listing enable these investors to “cash out.” However, with an IPO, there is a “lockup” period, typically between 90 to 180 days, in which shareholders are restricted from selling outside of the IPO. A direct listing has no lockup restrictions.

With a lockup period that extends three to six months for an IPO, new investors have some protection when the company goes public. They won’t face a slew of existing shareholders cashing out and putting pressure on the stock right away. Instead, the IPO gets a chance to “swim on its own” for a while to test the waters without interference.

There’s no such protection with a DPO. You could buy it the first day it trades and face immediate pressure from heavily invested insiders who are trying to sell the shares they held going into the first day of trading. You might argue that this is a more fair form of trading, and you wouldn’t have the end of the lockup period hanging over you, as you would with an IPO.

Other DPO advantages for companies include:

“Companies that pursue a direct listing have different objectives,” said Jack Cassel, Nasdaq’s vice president of new listings and capital markets. “Some companies don’t want to issue new shares and dilute their existing shareholders. … Other companies don’t have a need for additional cash in the near term. And some companies don’t want to have the lockup.” A direct listing can provide liquidity to shareholders, rather than targeting new money, as with an IPO.

Well-known DPO examples include cryptocurrency exchange Coinbase (COIN), messaging platform Slack (WORK), software developer Palantir (PLTR),and music streaming service Spotify (SPOT).

A few very large, consumer-facing companies choose direct listings “due to potentially lower transaction costs and other business-specific reasons,” according to the SEC. But “with no underwriters involved, companies will have no control over their initial investor base and may face trading volume challenges, which is why companies that choose this path are often ones that have strong brand recognition that can generate sufficient market interest.”

“Trading volume challenges” may sound arcane. What it means to the average investor is that a DPO might not be heavily traded once it’s on the market, and so its price could have sharper swings up and down. When volume is light, prices typically must fall or rise more dramatically to find interested buyers and sellers. You might hear this referred to as a wide “bid-ask spread.” So if you hold shares in a DPO, consider strapping in for a bumpy ride.

The DPO market is still dwarfed by traditional IPOs. In 2021, there were just seven direct listings in the U.S., according to Dealogic. In contrast, 397 U.S. IPOs in 2021 raised a total of $142.4 billion, according to Renaissance Capital, an IPO research firm.

Although a direct listing can be a cheaper, faster way for a company to go public, investors considering these vehicles should be aware of the unique risks.

A typical IPO undergoes a rigorous, months-long vetting process where the company’s finances and business plan are scrutinized by regulators and professional bankers. A direct listing skips the underwriter, and investors could be exposed to an illiquid market, wide-swinging prices, and other undesirable results.

As with most investing opportunities, let the buyer beware.