Transformations in Direct Listing Rules: Nasdaq's Recent Modifications to Pricing Constraints
Direct listing regulations continue to undergo revisions, the most recent of which is a rule change by Nasdaq approved on December 2, 2022. Although the Exchange has been striving to make the process more appealing and feasible, direct listings are yet to witness widespread adoption. As indicated in several reports, as of December 31, 2021, only 10 companies had taken the public route through direct listing. No further examples could be found since then. The slow pace is probably attributed to the stringent listing standards and rigorous process. Companies opting for this route, such as Spotify, Slack, Palantir, and Coinbase, have typically been more established ones.
However, Nasdaq and the NYSE persist with their strategy of fostering direct listings. After multiple consultations with the SEC, both Exchanges have approved rules permitting capital raising simultaneous to a direct listing. The Nasdaq Initial Listing Guide now incorporates the financial and liquidity requirements for direct listings on the Nasdaq Global Market and Nasdaq Capital Market, aiding quick reference. The most recent amendment to Nasdaq's rules enables a company to sell shares in the opening auction at a price outside the range stated in their registration statement—up to 20% below and 80% above.
Traditionally, direct listings involve a company conducting one or more private offerings of its securities and subsequently filing a registration statement with the SEC to register shares acquired by private investors. Though a placement agent/broker-dealer can assist in the private offering, it is not a necessity.
Private offerings are usually conducted under Rule 506 of Regulation D and are limited to accredited investors or very few unaccredited investors. Early investors face higher risks due to the absence of an established secondary market or a clear investment exit strategy. Yet, these investors are often afforded the opportunity to purchase shares at a lower valuation than the proposed IPO price due to these risks. This pre-IPO discount can vary but sometimes reaches as high as 20% to 30%. Consequently, early investors can reap substantial returns in an IPO process, regardless of whether it is through direct listing or traditional avenues.
The rule amendment approved on December 2, 2022, by the SEC came after three attempts by Nasdaq. It adjusted the pricing guidelines for new direct listings involving a capital raise, also known as "Direct Listing with a Capital Raise." Companies intending to list securities on Nasdaq must meet certain financial, liquidity, and corporate governance criteria.
To qualify for a Direct Listing with a Capital Raise, the combined market value of the company's publicly held shares before the offering and the shares to be sold by the company in the direct listing must be at least $110 million, or $100 million if the company has stockholders’ equity of at least $110 million. This is in contrast to the IPO value of $45 million. The recent amendment has changed the pricing provision.
The pricing amendment now allows the execution of a Direct Listing with a Capital Raise under two circumstances: (i) if the actual price calculated by the Nasdaq Halt Cross is at or above the price that is 20% below the lowest price of the disclosed price range; or (ii) if the actual price calculated by the Nasdaq Halt Cross is at or below the price that is 80% above the highest price of the disclosed price range. For the Nasdaq Halt Cross to execute at a price outside of the disclosed price range, the company is required to publicly disclose and certify to Nasdaq that such price would not materially alter the company’s previous disclosure in its effective registration statement. Moreover, the registration statement should include a sensitivity analysis explaining how the company’s plans would change if the actual proceeds from the offering are less than or exceed those from prices in the disclosed price range.
In the background of direct listings, a company typically executes one or more private offerings of its securities, post which it files a registration statement with the SEC to register the shares bought by private investors. The assistance of a placement agent or a broker-dealer, although beneficial, is not mandatory. Usually, such private offerings operate under Rule 506 of Regulation D and cater primarily to accredited investors or a handful of unaccredited investors.
Investing early in these offerings often entails increased risk due to the absence of a well-established secondary market or a clear exit strategy. However, this elevated risk usually results in private offering investors procuring shares at a lower valuation than the intended IPO price. The discount can range up to 20% - 30% of the IPO price, and early birds can often enjoy handsome returns from an IPO process, either via direct listing or traditional routes.
The process of a private offering or multiple offerings can span over an extended period. Before launching a public offering, most companies complete several rounds of private offerings, commencing with seed investors and typically through series A and B rounds. Companies also often extend options or direct equity participation to their officers, directors, and employees. In a direct listing, all such shareholdings can be registered for resale in the initial public market.
Coming to the recent rule amendment, on May 19, 2021, the SEC approved Nasdaq's proposal for direct listings with a concurrent capital raise, eliminating the need for an underwriter. Nasdaq refers to this process as a "Direct Listing with a Capital Raise." Shortly after SEC's approval, Nasdaq proposed an amendment to revise the pricing parameters for new direct listings with a capital raise. This proposal was finally accepted by the SEC on December 2, 2022, after three proposals.
The amended rule has relaxed the pricing constraint that previously required the full quantity of the order to be sold within the stated price range. It now permits a Direct Listing with a Capital Raise to be executed if the actual price calculated by the Nasdaq Halt Cross lies within a broader range—either at or above 20% below the lowest price of the disclosed price range or at or below 80% above the highest price of the disclosed price range.
To conduct a Direct Listing with a Capital Raise outside the disclosed price range, the company is obligated to publicly disclose and certify to Nasdaq that the new price would not significantly alter the company's prior disclosure in its effective registration statement. The effective registration statement should also include a sensitivity analysis, elucidating how the company's plans would be affected if the actual proceeds from the offering are less than or exceed the amounts from prices in the disclosed price range.
In conclusion, these transformations in Nasdaq's rules for direct listings not only facilitate the process of listing but also provide more flexibility to the companies opting for it. However, these modifications also place greater responsibility on these companies to ensure accurate disclosures to investors and the market.