Direct Listings, Myths and Facts

0:00:05 The content here is for informational purposes only, should not be taken as legal business
0:00:10 tax or investment advice, or be used to evaluate any investment or security and is not directed
0:00:15 at any investors or potential investors in any A16Z fund. For more details, please see
0:00:21 a16z.com/disclosures. Hi, everyone. Welcome to the A16Z podcast.
0:00:26 I’m Sonal. We’ve covered a lot of company building advice, including strategic financial
0:00:30 milestones for startups from the case study of the Open Table IPO on the show a couple
0:00:36 of years ago and a list of 16 things CEOs should do before the IPO and shared a detailed
0:00:42 IPO readiness checklist to also recently sharing the behind the scenes process of the roadshow
0:00:47 and pricing, all of which you can find at a16z.com/ipos.
0:00:51 You can also find at that link our explainer about another route to the public markets,
0:00:56 the emerging trend of direct listings, which is the topic of this episode. There, Jamie
0:01:00 McGurk explained the process and tradeoffs of the methods in detail for those who are
0:01:05 interested. But in this episode, we bring together two experts from the front lines,
0:01:10 the architect of the direct listings and their current form, Barry McCarthy, CFO of Spotify
0:01:15 and former CFO of Netflix, along with Stacy Cunningham, the president of the exchange
0:01:19 where they were listed, the New York Stock Exchange, to share more about the what, the
0:01:25 how, and the why from an insider perspective. We also touch on the big picture and secular
0:01:28 shifts in the public and private markets, go into the nuances of all the different
0:01:34 pricings and market mechanisms involved, share some behind the scenes details on the process,
0:01:39 and throughout, we demystify some common myths around both methods for going public.
0:01:44 But first, we begin with the differences between direct listings and IPOs. Let’s break down
0:01:48 what a direct listing is, how it works, some common myths and misconceptions. The reality
0:01:53 is that both are valid pets. People will take whatever pets they need to go public. And
0:01:56 there’s some people may go to the IPO route, and then there’s those I may want to go the
0:02:00 direct listings route. The number one question I want to start with is the main differences
0:02:04 between a direct listing and an IPO. Because one of the things that Jamie and I talked about
0:02:09 a lot is that the actual activities are very similar. You still have to engage with investors.
0:02:13 You still have to provide information, but there’s key differences. And one is that there
0:02:18 is no O or offering. The filing process is the same. You’re still finally submitting
0:02:25 an F1 or an S1. So that’s the same. Your obligations as a public company are the same. The differences
0:02:30 come down to one, it’s equal access for everyone, all institutions and retail, and there are
0:02:36 no lockup periods. And can we quickly answer the question of why, what is the point of
0:02:40 doing this? There are a number of reasons why companies would choose to access the public
0:02:46 markets. One is access to capital. Two is liquidity for early investors or for their
0:02:51 employees, as many of them are getting RSUs or options for many years and want to have
0:02:58 access to liquidity there. Three is the currency so they can engage in M&A. And four is just
0:03:02 the visibility of being a public company so they can go out and attract new customers
0:03:06 by saying they’re already a publicly traded company and gives them a certain credibility.
0:03:11 So I mean, those are kind of the four drivers and traditionally raising capital or access
0:03:15 to capital was the primary driver for companies to go public. Which these days you need less
0:03:19 because there’s more and more capital available in the early stage markets as well. And even
0:03:22 late stage investors have come into the early stage markets. As we all know, there’s a lot
0:03:27 of secular shifts that are also driving a lot of this. And importantly, you can either
0:03:31 raise it before in the private markets or raise it later in the public markets. If you choose
0:03:36 a direct listing, it doesn’t mean you don’t have access to capital. You’re just decoupling
0:03:40 the raising of capital from the moment in time that you’re listing. You just don’t need
0:03:44 it right now. It’s all about timing. Yeah, I would say if you need liquidity and you
0:03:49 want efficiency, then pretty tough to beat the public market where price is the ultimate
0:03:55 clearing mechanism for supply and demand. And you only have to look to WeWork to convince
0:04:00 yourself that the private market sometimes not very efficient in terms of setting price.
0:04:04 Bad habits grow quickly with big companies. You start to see that if there isn’t good
0:04:07 discipline and governance and they’re much larger, it’s much more impactful with a large
0:04:13 company. You don’t have the same kind of valuation that you get from the public markets because
0:04:16 there is less liquidity, less buyers and sellers. There’s a smaller subset of the market determining
0:04:22 the price. But in a worst case scenario, you actually have misvaluations that are intentional,
0:04:27 right? So there’s a lack of transparency in the private markets that can lead to misvaluations
0:04:32 and that can impact your employees when they’re part of that transaction.
0:04:39 The private market doesn’t enable the flow of information nearly as well as the public
0:04:47 market does because filing requirements. And so oftentimes we would find that the employees
0:04:52 were being taken advantage of by large investors who were willing to provide liquidity, but
0:04:57 at less than let’s say the full conviction price. And ironically, they had more information
0:05:03 about the performance of the business than the employees did. We had no ability to restrict
0:05:10 the sale of shares in the secondary market, none. And for an assortment of tax reasons
0:05:15 unique to Sweden, we had relatively short life options. So the company had been around
0:05:21 for 10 years. Many employees had options that were expiring, they needed to sell them. In
0:05:27 total, before we won public, there were $3 billion that had traded hands in the secondary
0:05:32 market in the year before we won public in 2017, a billion to change chance, which would
0:05:37 have made it one of the largest tech IPOs that year, I think.
0:05:40 Right. And it’s by the way, just a quick note on this. One of the things that Jamie wrote
0:05:45 about in the direct listings post that we wrote is that if you think about the difference,
0:05:48 because I asked why wouldn’t you just do all this in a secondary market versus in like
0:05:54 the public markets, is that a secondary market is not a true marketplace because you’re matching
0:06:00 an end of one buyer with an end of one seller, whereas a true marketplace of the public markets
0:06:05 allows the true market price to be set because you have more volume, more people, more buyers
0:06:08 and sellers to actually reach that sort of equilibrium of that pricing.
0:06:13 A traditional IPO is just a financing event. And it comes with lots of public disclosures,
0:06:20 scrutiny, rigor. But at the end of the day, narrowly from a CFO perspective, it’s about
0:06:24 raising money. So the question is, can you do it cost-effectively there or are there
0:06:29 other opportunities that you can exploit to your advantage in a relatively low-cost way
0:06:34 because of inefficiencies in the capital markets to raise money? Like today, you’d be hard
0:06:39 pressed to argue that there isn’t a very inexpensive capital to be had in abundance.
0:06:43 You want to think about the difference between raising capital and access to capital.
0:06:44 That’s a really important nuance.
0:06:50 I’ve been at this for 227 years. Companies were not IPO-ing back then. They were direct
0:06:54 listing. They were becoming public companies and being traded on an exchange, and then
0:06:59 they had access to capital through that mechanism. It’s only been since the ’70s that there
0:07:04 is now a offering that is part of that, where raising capital is the only way to come to
0:07:08 the public markets. And that’s just not true. And so Barry challenged that perception that
0:07:10 you have to raise capital to become a public company.
0:07:16 I love this anecdote. I read it first time in an article authored by Alan Patrikoff.
0:07:21 Nasdaq is founded in ’71, later that year. What we now understand to be tech IPOs happens
0:07:28 for the first time until comes public. 64 underwriters, they raise $8 million. And it’s
0:07:32 roughly the same process today as it was then.
0:07:37 That’s insane given how much things have changed. Can you guys answer the question then about
0:07:41 the relationship with investors? Because if there is one advantage supposedly of the road
0:07:47 show process, first of all, the criticism is that it’s handcrafted. It’s hand-allocated.
0:07:51 It’s not pure mathematical. But the advantage of that hand-crafting is you’re essentially
0:07:56 selecting in the investors, the big institutional investors you want to hold your stock.
0:07:59 There’s a lot of conventional wisdom here, which I think is ill-considered.
0:08:00 Go ahead.
0:08:07 So what then is the advantage of having those institutional investors hold your stock?
0:08:09 Oh, actually, that’s my question for you.
0:08:16 Yeah, I don’t think there is one. I used to think price stability. But then I came down.
0:08:24 As I watched the average number of shares traded in Netflix over the years decrease significantly
0:08:32 as the dollar value of daily trade skyrocketed, I realized that the price isn’t set by the
0:08:37 long-term shareholders. They don’t participate at all. Their shares are on the shelf. It’s
0:08:41 the high-frequency traders and the hedge funds who are setting the price.
0:08:45 It’s artificially constrained in an IPO. Even the long-only institutions that might hold
0:08:48 a stock for a long period of time aren’t getting the allocation that they might want at the
0:08:53 time of the IPO. So then they’re left coming into the market later. So it takes a company
0:08:57 more than six months to get to where they finally can have all investors with access.
0:09:02 Right. They have to build up their position over time because of the such a limited volume
0:09:07 that’s given up at the actual listing. Yes. It’s artificially constrained because they
0:09:09 might not get the allocation that they were requesting.
0:09:14 So the second argument I’ve heard is that, well, if they can’t accumulate a position
0:09:20 in the IPO, they won’t ever own the stock. And I’ve seen many examples where that’s just
0:09:21 not true.
0:09:25 So it’s conventional wisdom that you’re basically saying is just false. These are no longer true
0:09:26 or they were true at maybe at one point.
0:09:31 Well, I would say it’s not without its advantages, but the principal advantages you get to have
0:09:35 conversations with really smart people who make good use of your time because if they
0:09:38 do decide to buy, they’re buying a lot.
0:09:41 And those conversations can still happen in a direct listing.
0:09:42 Absolutely.
0:09:43 Absolutely.
0:09:44 And did.
0:09:47 One of the other differences is because you don’t have an underwriter in a bank, you don’t
0:09:51 have a stabilization agent coming out of a direct listing, but you do have a DMM in
0:09:55 both of those cases and they do commit capital throughout that process. And it might make
0:09:59 sense to just take a step back and talk about how we open stocks every day.
0:10:02 Every company that’s listed on the New York Stock Exchange has a market maker that’s
0:10:03 assigned to that company.
0:10:05 That’s an actual person, not a machine.
0:10:09 It’s an actual person and a firm behind the person. And it’s known as the designated market
0:10:12 maker or DMM.
0:10:17 That person has the responsibility to open stocks every single day and close them every
0:10:23 single day. And they commit capital when there’s a disparity and they can step in and facilitate
0:10:29 that process. So every day there’s a reference price. In a stock on a normal day of the week,
0:10:33 that reference price is the prior day’s closing price. And so the market knows this is where
0:10:35 the stock closed yesterday.
0:10:40 In the case of an IPO, it’s the IPO offering price. You know, where do those shares trade
0:10:41 hands?
0:10:43 Which is different than the listing price.
0:10:46 Which is different than the listing price. And in all cases, it’s different than where
0:10:50 it opens, right? So on the case of a direct listing, the SEC was saying, well, there’s
0:10:56 no price. What’s the market going to do? And so we tried to explain that those prices,
0:11:01 whether it’s the last day’s closing sale or the IPO offering price, do not influence where
0:11:06 the stock opens the next day. The stock opens where supply and demand is offset.
0:11:07 The true market price.
0:11:11 Yeah, where there is a market price. That might inform an investor of what the prior
0:11:15 participants valued the company, but it doesn’t indicate at all where it’s going to open the
0:11:19 next day. And if you look through history, it’s not at all reflective of anything.
0:11:23 It’s a funny little vestigial artifact, like the tailbone of the IPO process, this idea
0:11:27 that you need this reference price in the first place. It’s almost like a psychological
0:11:28 crutch in many ways.
0:11:33 We have to file rules with the SEC around this. So it’s set based on secondary trading.
0:11:38 If there is secondary trading, an active secondary market. And if it’s not, it’s set by the
0:11:40 New York Stock Exchange in consultation with the financial advisor.
0:11:44 Do you think that at some point in the evolution of the direct listing, we should just drop
0:11:48 the reference price altogether and just let the market decide by pure matchmaking and
0:11:49 transparency?
0:11:51 We do let the market decide.
0:11:52 Right.
0:11:55 This is really just a number, just like it is on any other day. It did turn out that
0:12:01 it was a useful number to have for many broker dealer systems who are used to inputting a
0:12:07 number. There is a certain psychology associated with it because it gets used as if it wasn’t
0:12:12 offering sometimes in the media and you’ll see, in the case of Slack or Spotify, hey,
0:12:15 this was up or down X amount from its reference price.
0:12:18 But in fact, it’s finding true equilibrium, which is actually the better point.
0:12:19 Right?
0:12:25 The most relevant number is where is it trading now based on demand and buyers and sellers?
0:12:30 We set the reference price the night before and it goes out to the industry so they can
0:12:35 leverage that number. But it’s really the morning, the next day where the price discovery
0:12:38 starts. And that’s when the DMM is looking at what all the buy interest and sell interest
0:12:42 is. They’re choosing that price. In the case of an IPO, they’re doing that in consultation
0:12:45 with the underwriter. In the case of direct listing, they also work with the financial
0:12:48 advisor and letting them know what they’re seeing and where they’re planning to open
0:12:49 the stock.
0:12:52 What’s the point of the stabilization? Can you explain that a little bit?
0:12:57 It’s just intended to provide some stability coming out of the offering so that you would
0:13:00 commit capital to maintain that kind of offering price.
0:13:05 The recurring theme that I’m hearing is that there’s a lot of orchestration to make markets
0:13:08 natural. And why not just let markets be natural?
0:13:14 And that was one of the organizing theories behind. Wisdom of crowd, Trump’s expert intervention,
0:13:19 if you just eliminate all the friction that’s been created over time, you’d get to equilibrium
0:13:20 right quick.
0:13:26 I do think one of the myths around the direct listing is that there are, that there’s no
0:13:31 human intervention. And so you still have that market maker at the time of opening who’s
0:13:36 looking at all the supply and demand and choosing the price and committing capital. It’s not
0:13:40 just an algorithm because if we’re just an algorithm, you can open right at 930. But they’re
0:13:45 looking for enough liquidity so they feel like it’s really representative of supply and
0:13:47 demand and representative of the market.
0:13:52 So it can take a long time. And in direct listing, it takes even longer. I mean, we had a universe
0:13:58 of two so far to date. Spotify was 1243. Slack was 1208. Alibaba was the largest IPO of all
0:14:02 time and it opened at 1153. So we’re kind of in a universe where they’re a little bit
0:14:08 later. But when you look at the amount of shares that traded hands, that’s where it gets
0:14:14 really interesting because Slack, as an example, the more recent one where I think now it was
0:14:18 more well known by the market, there are many retail broker dealers that didn’t allow the
0:14:23 retail firms to trade in Spotify’s listing because they were concerned that it was an
0:14:25 untested mechanism and they were trying to protect their clients.
0:14:28 This is a classic theme to we’re trying to protect these people when in fact they’re
0:14:31 depriving sometimes some of those opportunities of access.
0:14:35 I think there were some concern that if things didn’t go well, the retail clients would be
0:14:36 the ones to pay for it.
0:14:37 Right.
0:14:41 So it’s getting a little bit more conservative. With Slack, that wasn’t what we saw. And if
0:14:46 you look at the amount of volume that traded hands in that opening trade on Slack, it was
0:14:52 almost $1.8 billion on a company whose market cap was $19 billion. That is the third largest
0:14:59 opening trade period of all time. And if you look through the three largest, one was Alibaba,
0:15:05 it was a $25 billion IPO at Facebook and then Slack. That’s real price discovery and it’s
0:15:10 a much, it was a much smaller company. So to have a trade that size really indicated
0:15:15 the overall interest, which means you’re getting to a more mature place much more quickly.
0:15:20 The Citadel handled both Slack and Spotify and did just a remarkable job.
0:15:27 Yeah, they traded over 20% of volume in those securities and committed a lot of capital
0:15:31 through that process. So while there’s no stabilization agent, you always have a DMM
0:15:34 and they’re going to commit capital throughout that process.
0:15:38 So your point is that the myth is that it’s purely algorithmic when in fact there is going
0:15:39 to be a human agent in the middle.
0:15:43 Yeah, there’s a human being that is overseeing the opening of that stock. The model that
0:15:47 we have in place, there’s a human being that oversees the opening of stocks all the time.
0:15:53 If it’s not as complex situation that can be automated, the more complex the situation
0:15:57 is and so IPOs are typically more complex than a direct listing, you increase the level
0:15:58 of human participation.
0:16:03 I would say the other myth is that direct listings open differently than traditional
0:16:04 offerings.
0:16:08 Yeah, what we do is we collect the buyers and we collect the sellers and the DMM looks
0:16:12 at that book of business and figures out where is their price. Now they’re looking not just
0:16:17 for where does supply meet demand, but they’ll wait for a time and this is why it sometimes
0:16:21 takes a little bit longer to see that there’s stability above and below, that there’s enough
0:16:25 interest below the opening price and above the opening price so that when it opens,
0:16:30 it isn’t very volatile, which is why it takes some time to get to a place where it really
0:16:36 feels like it’s representative and what’s fascinating is one of the concerns that we
0:16:40 had and there were a lot of people involved in this process who’ve been in the markets
0:16:44 for a long time that disagreed on this point that there would be buyers and no sellers.
0:16:47 So when Spotify came to market, I mean I didn’t think it was in your F1 barrier that there
0:16:51 would be more volatility, it could be more volatility in the listing, but Spotify actually
0:16:58 traded with less volatility than the typical tech IPO and Slack was, there was so little
0:17:00 volatility in the first day of trading Slack.
0:17:04 So what I love about that though, this is where there were of course plenty of headlines
0:17:09 in both cases that, oh my gosh, the next day or it’s now going low when in fact it doesn’t
0:17:15 have the pop phenomenon, the performative ticker type of thing where everyone is avidly
0:17:19 looking at the opening price and does it pop or not and that is the thing that people have
0:17:23 been so trained that it’s actually, they’re missing the point that, hey, hey, wait a minute,
0:17:27 that pop thing is an actual distortion when you actually want the true state.
0:17:32 Yeah, there is a viewpoint that the bigger the pop, the more successful the IPO and it’s
0:17:34 actually the opposite of that.
0:17:40 And in fact, as we know, as we all know, many IPOs sort of are artificially under price
0:17:44 in order to orchestrate the sensation of a pop.
0:17:46 I don’t know if there’s a good reason for that.
0:17:51 I think it worked in the existing system because you essentially give people these sensation
0:17:56 that they are getting a gain, but what is the point of the pop and can the pop go away
0:18:00 altogether with a direct listing?
0:18:03 We talked about the fact that companies are coming to market much larger.
0:18:07 Historically, when they were much smaller and they were lesser known and there wasn’t
0:18:12 a lot of public market investment in the private market space, shares were being allocated
0:18:16 in the IPO and investors were taking a little bit of risk with a lesser known company and
0:18:19 they were taking it with this understanding that they’re going to get some benefit on
0:18:20 day one.
0:18:22 That game has changed.
0:18:26 Everything now doesn’t have the same risk profile with companies that are well-established
0:18:29 large companies to this date.
0:18:35 So I think it’s somewhat, the markets have evolved in a way that that first day pop is
0:18:36 really changed.
0:18:42 I was out here a couple of weeks ago at a conference, a guy named Jay Ritter from Florida
0:18:48 done some research over the last 10 years on the size of the pop and ironically the pop
0:18:56 was the largest for the two premier investment banks and I think it peaked out at 36, 37%.
0:19:00 So everybody talks about the fee being the cost of the transaction, but in our case,
0:19:05 we were looking at transactions that had raised more than a billion because the rule of thumb
0:19:09 is you would issue say 10 to 15% of the outstanding shares.
0:19:16 So if we had a 20 billion market cap, we would have done a $2.5 billion listing.
0:19:23 So from 2011, I think there were 11 transactions that have raised more than a billion.
0:19:31 And if the objective is 100% turnover in shares issued, which it is in a typical transaction
0:19:40 and say 30% appreciation first day, if the bankers and the capital market experts are
0:19:46 really expert, you would expect that most of the time they would achieve those two objectives.
0:19:53 So one of the 11 transactions, 9%, hit the benchmark for first day appreciation, all
0:20:00 the others were over and under and only two hit the turnover objective.
0:20:02 So basically they’re all mispriced.
0:20:03 They’re all mispriced.
0:20:04 And money is being left on the table.
0:20:08 And you have to ask yourself, is it happening because they’re really not very capable?
0:20:10 No, that’s clearly not the case.
0:20:13 So the world’s leading experts, no question about it.
0:20:17 It’s because the process is just fundamentally broken in my view.
0:20:19 So actually, Barry, why don’t you tell us about this process?
0:20:20 Like what did it take?
0:20:25 I mean, honestly, it’s nuts that you guys decided, hey, we’re going to use this old
0:20:29 tool that’s been around that actually is used for companies that are splitting or trying
0:20:34 to come back from bankruptcy or debt, and we’re going to now use it to go public.
0:20:36 Tell us more about why you did that.
0:20:38 We needed to become public.
0:20:43 We had a billion, 700 million of cash on the balance sheet and no debt.
0:20:47 If we could find a way to do it without raising capital, which we didn’t need and couldn’t
0:20:53 deploy, we wouldn’t be diluting our shareholders, our founders, our employees.
0:20:57 It was in our economic self-interest to explore alternatives.
0:21:02 And I felt I had my Wizard of Oz moment when I thought about the scale of the business
0:21:06 relative to other public companies that I had known.
0:21:11 The lesser CEO wouldn’t have had the courage to be different, being different as part of
0:21:13 the ethos of the company.
0:21:19 And so I began the conversation with Daniel by saying to him, hey, I have this idea.
0:21:21 It’s never been done before.
0:21:27 And for him, one of his primary objectives was equal treatment for employees.
0:21:35 So the absence of the lockup, the radical transparency, the equal access, the price discovery, well,
0:21:37 we never could have done it without the folks at Latham.
0:21:41 It’s a relatively easy thing to ask the question, how do I do this?
0:21:44 Could I do this and explore and tease out all the options?
0:21:46 You mean Latham and Watkins legal firm?
0:21:47 Yeah.
0:21:48 Right.
0:21:52 It took almost two years of prep work to make it live.
0:21:57 I mean, this is hyper technical stuff and engage the SEC constructively in a conversation
0:21:58 about how to do it.
0:22:00 It was in the process of doing that.
0:22:01 It was a well-trodden path.
0:22:03 Many people had done it.
0:22:08 The stocks had performed horribly and you had to ask yourself, well, was it the transaction
0:22:09 itself?
0:22:12 It was inherently flawed or was it the companies that the world didn’t care about or was it
0:22:15 some combination of both?
0:22:18 If you’re using a well-trodden path, why do you have to spend time convincing the SEC
0:22:19 about it?
0:22:25 Well, the backstory here is when we began the process, we thought under section 12 of
0:22:31 the 34 Act that we could become a publicly traded company.
0:22:34 And the SEC was dead set against that.
0:22:37 We had a lengthy negotiation about it.
0:22:42 At the end, they got what they wanted, which was the 33 Act registration, which brings
0:22:47 with it strict liability for companies different from a traditional 10 to 5 defense.
0:22:52 I think the perspective being that even though there weren’t shares being sold, it still was
0:22:57 an offering to be a public company was the SEC’s view.
0:23:01 And if you made a material misstatement, you were guilty.
0:23:06 You didn’t need to prove reliance, you didn’t need to prove many of the other nuance things.
0:23:07 You were just toast.
0:23:09 That’s what they wanted.
0:23:11 But what I wanted was radical transparency.
0:23:18 I wanted to be able to speak openly to prospective investors as if we were already public.
0:23:23 But traditionally, in a traditional IPO and a 33 Act filing, there’s something called
0:23:26 the quiet period that ties your hands.
0:23:30 Specifically, what I wanted was in terms of acting like a public company was to be able
0:23:35 to hold an investor day, present in great detail the strategy of the business and allow
0:23:40 investors to see the people who are running the business in order to make an informed
0:23:44 decision about whether they wanted to invest behind them and the strategy.
0:23:47 And historically, that’s not done in IPOs.
0:23:52 There’s a traditional roadshow process, but it doesn’t include that.
0:23:56 And then secondly, I wanted to give guidance like a public company.
0:24:02 It was a muscle that we’d been developing over many years before we began the process.
0:24:07 And instead of the kabuki dance that happens in a traditional offering, I thought we should
0:24:13 tell investors ourselves, now, after the fact, I came to understand with Michael Grimes help
0:24:17 more recently, just how important the giving guidance is because if the company doesn’t
0:24:22 do it, nobody else in the investor community is doing it.
0:24:27 And if the market has no idea how you’re going to perform, they’ll guess, and their
0:24:32 guess won’t be nearly as accurate as your guess would be and bad things would happen
0:24:33 as a consequence.
0:24:40 I think that work that Spotify and Latham and we did also at times was important to establish
0:24:46 what the direct listing is today, because now it does offer fair access and full transparency,
0:24:50 which had they not persevered on that front to be able to have an investor day and have
0:24:52 that broadcast to anyone.
0:24:53 So it’s not just a roadshow.
0:24:55 That goes only to private institutional investors.
0:24:59 The traditional IPO, there are shares being allocated and there’s a story being told to
0:25:01 a select group of people, not just to anyone.
0:25:06 So when Spotify blazed this trail, it was everybody can hear the same information.
0:25:07 At the exact same time.
0:25:11 You just go to the Spotify website, you can watch the investor day and you get four hours
0:25:15 full of what’s their story, what’s going on.
0:25:16 And anyone can see it.
0:25:18 And then when it starts trading, anybody can participate.
0:25:24 There were over almost 19,000 people who’ve streamed that investor day, which would never
0:25:25 happen in an additional roadshow.
0:25:26 That’s fair access.
0:25:28 That is very democratizing.
0:25:31 My mom and dad could tune in as well as like fidelity and all the big investors.
0:25:35 Equal access was a very important objective for us.
0:25:39 Two things I will say that don’t get quite as much attention, but are byproducts of being
0:25:43 public companies is it does introduce a lot of discipline and governance when a company
0:25:48 is public, because there is so much transparency and so many aspects of your business are filed
0:25:49 with the SEC.
0:25:53 But the other thing that often gets left off and talked about is, is you’re then allowing
0:25:55 others to share in your success when you’re a public company.
0:26:00 I’m glad you bring that up, that there is a lack of access for regular retail investors,
0:26:05 that they don’t have access to that capital because of the company staying private longer.
0:26:06 I just don’t think it’s particularly important.
0:26:10 Like in a traditional IPO, the retail allocation is about 10%.
0:26:12 Their growth in the market after they’re public, right?
0:26:13 Exactly.
0:26:19 At a Salesforce IPO in 2004, so 15 years ago, if you had the opportunity, which retail
0:26:25 doesn’t, to buy into the IPO, that performance is up 5,500% since their IPO pricing.
0:26:29 But even if you look at the first day of trading where then retail does have access, up 3,300%,
0:26:32 compared to 163% in the S&P 500.
0:26:35 That’s a big difference, because while I agree with you, Barry, that the retail allocations
0:26:40 are so small and already a small float to begin with, the fact is that retail investors are
0:26:41 deprived of that.
0:26:43 That’s something very democratizing about going public.
0:26:48 You both think a really good point about the structural change in the evolution of the
0:26:49 capital market.
0:26:56 So by way of comparison, when we took Netflix public in 2002, there were 600,000 subscribers.
0:26:58 There were 76 million in revenue.
0:27:05 We had, I think, 13 million of cash on the balance sheet, no secondary sales.
0:27:11 When I left at the end of 2010, so eight years later as a public company, it was 2.2 billion
0:27:22 of revenue, 20 million subscribers and 150 of net cash, net of debt on the balance sheet.
0:27:28 So fast forward, historically, early buyers of the public market have moved downstream
0:27:33 into late-stage private, and the private market is a washing cash, which is enabling
0:27:35 companies to stay private longer.
0:27:44 Spotify is coming public. It’s more than 10 years old. It has 4.4 billion USD of revenue,
0:27:52 71 million subscribers, a billion to trade it in the 12 months prior to coming public
0:27:56 in the secondary market, and 1.7 billion of cash.
0:28:01 So almost twice the size of Netflix after Netflix was public for eight years.
0:28:04 That never happened before.
0:28:10 Yeah, we call it the quasi IPO, which is this phenomenon that companies stay private longer.
0:28:13 Well, I think you don’t get the valuation that you get from the public markets.
0:28:15 I mean, the public markets is real price discovery.
0:28:19 You have real buyers and sellers coming together, and that’s exactly what the direct listing
0:28:21 is designed to address.
0:28:25 What about on your end when you had to do from the exchange side, I mean, how did you guys
0:28:26 have to do this?
0:28:30 Yeah, I think some of the things that Barry touched on, we had to work with as well because
0:28:33 it was part of what our listing standards require, and so we had to adjust some of the
0:28:38 rules that we have at the New York Stock Exchange, not too dramatically because it isn’t so unique,
0:28:44 but a couple of the things that we had to do was introduce the concept of a financial
0:28:45 advisor.
0:28:49 The SEC wanted to know that there was a bank or somebody.
0:28:54 The secret about the stabilization efforts, the market makers would tell you is that the
0:28:59 banks today don’t really commit capital to stabilize. They don’t really underwrite anything
0:29:00 anyway.
0:29:05 Think of the value exchange. It really happens in a traditional IPO. It’s exactly what happens
0:29:10 in a direct listing except the fees paid in a direct listing bear no relationship to the
0:29:14 size of the offering because there’s no offering. We’re just paying them for their advice and
0:29:18 counsel, which is the value they provide in a traditional.
0:29:22 Well, and also the relationship brokering, but that’s something that in this case, again,
0:29:26 with the structural shift of the markets and the fact that a lot of late stage capital
0:29:30 investors are following these companies early on, there’s a lot more public information
0:29:32 about these companies, what their products are, et cetera.
0:29:36 I mean, didn’t you guys still do relationship building with some of these institutional investors?
0:29:40 That’s exactly the point. Most of that is happening regardless, and it has been happening
0:29:45 for several years. And so by the time you’re ready to go public, you have already formed
0:29:49 strong relationships with the people who are most likely to buy your offering.
0:29:56 So in a traditional allocation, I think it’s 26 to 35% of the offering would go to the
0:30:06 top 10 investors and the next 25 to 30% would go to the next 20. Retail gets 10 and everybody
0:30:10 else gets a balance, and it’s the same 200 investors every single deal, deal after deal
0:30:14 after deal. So you already have relationships with the accounts that matter.
0:30:17 The fact that you’re doing an investor today doesn’t prevent you from going out and talking
0:30:22 to investors that you want to target. Slack did that. They did like a mini road show
0:30:24 as well as an investor day. Yeah, it doesn’t prevent you from doing that. It just allows
0:30:29 you to share information more broadly. Coming back to the road show stuff, we also met
0:30:33 with them there. So we were in Boston, New York, London, Stockholm, because given the
0:30:39 scale of the business, you just couldn’t afford to ignore it. And the day of the investor
0:30:42 day, we had 18 research analysts already writing about the story.
0:30:45 What do you guys think of this other recurring theme here, that Slack is a company people
0:30:50 use Spotify? You guys are one of the world’s largest streaming music companies that something
0:30:54 people use all the time in their daily lives, that only well-known brands can do a direct
0:30:59 listing, that you can’t be like a wonky software company that only certain businesses use,
0:31:04 for instance. What would you say to demystify that myth or respond to those folks?
0:31:10 It probably was helpful for the first one, Spotify, to have a well-known brand. I coming
0:31:14 out of the Spotify listing thought, “Oh, you need to have a well-known brand, and you need
0:31:18 to have a distributed shareholder base and lots of holders, so that there will be liquidity.”
0:31:23 I’ve evolved that thinking after Slack. And it’s less, while Slack is a very well-known
0:31:29 brand in the tech community, it’s not a household name to many people. And they didn’t have
0:31:33 a broad distributed shareholder base, but you need to have sellers, right? You need to have
0:31:38 some liquidity. So that’s really, I think, a myth that you need to have a household name.
0:31:42 Yeah. And I would also point out that this is where tech has a real inflection point,
0:31:46 because many, many years ago, my mom would never have said, “I’m investing in Twitter.”
0:31:50 She doesn’t even know what Twitter is. But they watch TV. Tech has permeated our lives
0:31:54 in a very different way. So I think we just have to acknowledge another huge secular shift,
0:31:56 which I think is another underlying reason right now is the time.
0:32:02 I think the reason there is more conversation about direct listing now is because of Slack,
0:32:06 right? After Spotify went, it was kind of a yawn. The view was, yeah, they’re different
0:32:11 through Swedish. It’s big scale. It’s like not everybody can do that.
0:32:15 It took a long time to bring this thing to life. Barry first came to the New York Stock
0:32:24 Exchange in 2016. And when I first had a conversation with Barry about this idea he had, I was certainly,
0:32:29 you know, I was not so concerned about Spotify and how it would go then. I was more concerned
0:32:33 about the second one, because not everyone has Barry McCarthy kind of at the controls
0:32:38 thinking about how this is going to go, thinking about all the things might miss something.
0:32:43 And Slack, I think that really told the market this is a tool people can use and it’s not
0:32:50 just a one time success story. What about the forward looking guidance? So you mentioned
0:32:54 that was really important to you to do that. And the difference between a direct listing
0:32:59 and IPO is in the case of an IPO, the filing does not become effective to like the night
0:33:03 of, whereas in the case of a direct listing, it can be rendered effective like 10 days
0:33:08 in advance or a certain period. So what was the point of the forward looking guidance?
0:33:12 Because I’m kind of hearing mixed messages on one hand where, yes, you guys want the
0:33:16 market to decide based on the true transparency of the information. But on the other hand,
0:33:20 we want to give guidance. I don’t quite understand the nuances of that.
0:33:25 Yeah. Well, let’s just acknowledge that there’s a school of thought that argues against the
0:33:29 wisdom of giving guidance. And I just think it’s foolish.
0:33:32 Guidance is definitely a hotly debated topic.
0:33:39 So the analogy I like to use is if you’re in a relationship and it’s date night, something
0:33:44 comes up at the end of the day, you’re supposed to meet at seven, you don’t show up till 10.
0:33:47 If you haven’t called, your night’s not ending well.
0:33:51 Whereas if you text and give an update, okay.
0:33:56 Right. Lands much better. Guidance is the equivalent of making the phone call or sending
0:34:02 the text. Now, one perspective on the wisdom of giving guidance as it relates to an IPO.
0:34:06 I previously mentioned there was this kabuki dance that happened. So the company has a
0:34:11 forecast. They don’t want to miss it when they share it with the bankers. So they detune
0:34:16 it. They hand it to the bankers during the IPO process. The equity research analyst for
0:34:20 your underwriters will come over the Chinese wall. You’ll, you’ll take them through your
0:34:27 forecast, teach them the business in preparing their own forecast. They’ll take the forecast
0:34:31 you gave them, which you detuned before you gave it to them, and they will detune it.
0:34:36 And then they will, they will basically teach the street because the SEC won’t allow you
0:34:40 to talk about future performance. They will speak for you to the street and then the street
0:34:46 will take the forecast they got from the equity research people, which was a dummy down version
0:34:49 of the dummy down version you gave them, and they will dummy it down.
0:34:50 It’s like a game of operator.
0:34:53 And so by the time the institutional investor gets it, there’s good chance you don’t even
0:34:59 recognize it anymore. But it’s the, it’s the underwriters, equity research people who
0:35:04 are teaching investors what the future performance of the business might be. So you can short
0:35:09 circuit that entire process by just telling people what it is you’re going to do. If you
0:35:14 look to the public market for best practice, most companies give guidance.
0:35:19 The counter view is that if you’re telling, if you’re providing quarterly guidance, you’re
0:35:23 managing your business to the quarterly guidance, investors are demanding that you hit those
0:35:29 numbers and that it creates a short-term view for, for leaders versus long-term and it’s
0:35:30 debated.
0:35:34 And my view is you’re getting held accountable for their expectations, whether you inform
0:35:40 them or not. As long as investors get rewarded based on quarterly performance, public companies
0:35:44 are going to be under a lot of quarterly performance pressure. That doesn’t mean that’s how you
0:35:49 need to run your company. In fact, if you do become short-term oriented and eventually
0:35:52 the performance of business will fall apart and so will your stock price.
0:35:55 Right. So your point is that you’re going to be held accountable for the expectations.
0:35:57 So you might as well control those expectations.
0:36:00 Yeah. So figure out what you need to do over the long run in order to be successful and
0:36:04 then break it down on a quarterly basis and tell them what that is. And sometimes they’ll
0:36:08 like what they’re hearing and sometimes they won’t. The only way to manage your stock price
0:36:11 is to take care of the performance of your business. And if you do that, eventually the
0:36:15 stock price takes care of itself. But coming back to the guidance thing, if you’re not
0:36:21 speaking in a direct listing, nobody is speaking in an informed way about what the expectations
0:36:22 are for the business.
0:36:28 Now, how the street interprets your guidance is something else entirely. So I was a public
0:36:36 company’s CFO for 35 quarters before Spotify. And for that entire time, we told the street
0:36:40 that our guidance was actually what we expected and people came to understand that. And we
0:36:46 said we were going to manage ourselves the same way at Spotify and still in our first
0:36:50 quarter, when we did what we said we were going to do, the stock traded down because
0:36:57 people had learned to expect outperformance in that first public quarter and it didn’t
0:37:03 matter that we told them that we were going to be different. They just didn’t hear it.
0:37:08 So there’s some puts and calls, but I think the wiser course is to try to lean in and
0:37:12 manage people’s expectations, recognizing that in a direct listing, there’s this vacuum
0:37:17 and it’s different than a traditional offering where the equity research of your underwriters
0:37:21 plays an important role in informing investor expectations.
0:37:25 What would you say to the myth that public investors don’t like direct listings?
0:37:30 During our roadshow, we spoke to a number of large investors and the biggest surprise
0:37:32 for me was their enthusiasm.
0:37:33 Why?
0:37:40 Because if you run a large portfolio, by the time you receive your allocation, it’s so
0:37:45 infinitesimally small as a percent of the assets you run, it’s completely immaterial
0:37:46 to you.
0:37:50 Oh, totally. The assets under management for most of these funds, I mean, how big a role
0:37:51 IPO is in these stocks play.
0:37:56 Yeah, so that big first day pop is meaningless for them and they get cut back in the allocation.
0:37:59 Yes, because of the limited volume.
0:38:03 So what’s different about the direct listing is if they have full conviction, they can
0:38:06 back a truck up and buy the whole thing and they love that.
0:38:07 Which then gets advertised.
0:38:12 I mean, part of why the process takes longer in the morning is we’re sending out an indication
0:38:16 of price range that’s much wider than you would in a normal IPO because this is the
0:38:20 price discovery process happening unlike the allocation the night before.
0:38:24 And so institutional investors can see that and determine where they want to put their
0:38:29 interest into the market and over time, it narrows down to a place and they can actually
0:38:32 attract more sellers by indicating their overall interest.
0:38:36 This is great because I think a common misconception that I’ve heard from a lot of the lay commenters,
0:38:40 which is not always fun to read Twitter, but a lot of people complain about the fact that
0:38:44 direct listings are self-serving for early stage investors because they don’t have to
0:38:45 worry about a lockup period.
0:38:49 But it does make a difference in the market side because of the availability of the volume
0:38:50 of that stock.
0:38:54 Lockups make a difference in how people trade and look at the stock for a period of time,
0:38:56 just knowing that there’s going to be shares that can come to market.
0:38:57 Right.
0:38:58 So you actually are obviously saying-
0:38:59 It’s an artificial constraint.
0:39:00 Yeah, it’s another artificial constraint.
0:39:03 You guys just short the heck out of the lockup best price and there’s all kinds of market
0:39:04 manipulation.
0:39:07 Yeah, you’re removing a lot of that trading that might occur around lockups.
0:39:08 Right.
0:39:12 That’s, in fact, the other secular shift we haven’t talked about is the reality of HFTs
0:39:14 like high frequency trading, hedge funds, et cetera.
0:39:17 All these things that have also changed the way markets transact around public.
0:39:21 We have to wrap up, but do you have any advice for how people should think about pricing their
0:39:22 IPO?
0:39:26 Because in the traditional IPO, you have the legacy of the sort of fake price that’s set
0:39:29 and then you have this and dance with the road show.
0:39:30 You’re not pricing your IPO.
0:39:34 You’re telling your story about running your business and the market is pricing your listing.
0:39:35 That’s actually the best advice ever.
0:39:36 But it’s true.
0:39:39 I mean, you’re running a business, you’re talking about what you have planned for the
0:39:43 business in the future and you share metrics and numbers and the market tells you what
0:39:44 they think your company is worth.
0:39:45 Barry and you were forced to do the reference price.
0:39:47 Would you like to get rid of it all together?
0:39:50 I think it was just completely irrelevant to the process.
0:39:52 It doesn’t matter whether it exists or not, honestly.
0:39:53 Nobody pays attention to it.
0:39:58 I do think, I think it’s been a helpful, from a mechanical perspective, it’s been helpful.
0:39:59 We worked with the SEC.
0:40:03 It was important to them that there be some reference out there in the market.
0:40:08 We introduced the concept of a financial advisor that would work with the DMM as needed.
0:40:13 We had to introduce a new way to meet our listing standards and we used a market cap
0:40:16 test because companies typically do that through the IPO.
0:40:19 So we had to introduce that piece of it.
0:40:24 And then the other things that the SEC wanted were the transparency and the filing, the
0:40:25 investor day.
0:40:30 We should give the SEC credit, especially a director of Corpfinn, Bill Himman, was really
0:40:34 constructive in trying to find a way to provide new tools in the market.
0:40:38 And we’ve had many conversations with them about what’s worked so far, what have we learned,
0:40:40 and what can we do in the future?
0:40:45 Could you introduce primary raising using the same mechanism if you wanted to kind of
0:40:48 recouple the raising capital?
0:40:49 Yeah, I would like to second that.
0:40:51 He led every meeting.
0:40:53 They were difficult discussions.
0:41:00 They went a long way to accommodate some of our disclosure requests in the context of
0:41:01 the 33 filing.
0:41:04 And I think the public interest was well-served as a consequence.
0:41:09 I mean, their job is to protect and ensure that there are healthy markets to protect investors.
0:41:15 Did you get critiqued a lot on the street or by your peers for this, like after the opening
0:41:16 itself?
0:41:17 How did you feel?
0:41:20 Caught a little bit of the dead cat bounce when people first began to hear about what
0:41:21 we were doing.
0:41:23 And no one knew how to understand it, interpreted it.
0:41:30 And so we spent time on background with members of the financial press and the media helping
0:41:33 them understand just what it was.
0:41:37 And then we stepped back and they performed a very valuable role, which is they debated
0:41:40 endlessly the pros and the cons of it.
0:41:43 And after that, I just went back to work exhausted.
0:41:47 I think to date, and it’s only been in universities too, it’s much more work for the company to
0:41:53 go the direct listing route than a more traditional IPO, where you sign up, show up and get shepherded
0:41:54 through the process.
0:41:58 I would say if you’re going to do an investor day, it’s considerably more work.
0:42:01 But aside from that, it’s pretty much the same.
0:42:07 And my team did it themselves with the lawyers for the most part, with on the back end, important
0:42:10 input from the banks, all three of them.
0:42:13 I was going to say though, for an investor day, just to be clear, that’s a single day
0:42:17 while it may take a ton of work to plan, prepare, share that story.
0:42:20 That’s all practice for your future earnings calls and everything else you’re going to
0:42:22 be doing and thinking anyway.
0:42:24 One more mechanical detail.
0:42:26 Why the ringing of the bell?
0:42:29 Because theoretically, you didn’t have to ring the bell anymore.
0:42:33 And I think it’s great because Stuart asked his mom to ring the bell for Slack’s idea.
0:42:35 So there are two different bells that you’re talking about.
0:42:36 One is the bell that starts trading each day.
0:42:41 So at 9.30, and that bell rings for 10 seconds, it actually tells the traders on the floor
0:42:44 that they have 10 seconds to get their orders in before the market is open.
0:42:45 They’re not looking at the clock.
0:42:48 And so the bell, they actually are very particular about the bell ringing for the right amount
0:42:49 of time.
0:42:54 And then it’s a ceremonial first trade bell that rings when the stock opens for the first
0:42:56 time as a public company.
0:43:00 And we give the opportunity for a CEO or whoever they might want to delegate that responsibility
0:43:01 to.
0:43:03 I have a question for Barry though, if we have one more minute.
0:43:05 Do you have the flags displayed anywhere?
0:43:07 What are the flags?
0:43:08 We do.
0:43:11 We have them in one of our large conference rooms.
0:43:16 So we were concerned that with this new way of coming to markets, things could go wrong.
0:43:19 And there are lots of things that run through your head.
0:43:23 At the time, I was chief operating officer, and so you worry about all the things that
0:43:24 could happen.
0:43:31 What we didn’t account for was that we would hang the wrong flag outside in honor of Spotify’s
0:43:35 listing day and an attempt to hang the Swedish flag outside.
0:43:36 Oh no.
0:43:38 Somebody grabbed the Switzerland flag.
0:43:39 Oh my God.
0:43:44 We hung outside the exchange for about seven minutes before it was realized that the wrong
0:43:46 country’s flag was put up.
0:43:52 On listing day, my wife had sent me a picture from the exchange, which I forwarded to Tom
0:43:56 Farley, and he wrote, he thought I was pulling his leg.
0:43:58 That was a joke.
0:43:59 Yeah.
0:44:00 So Tom was pretty upset about that.
0:44:03 And I said to him, Tom, this is the only thing that goes wrong today.
0:44:04 It’s a win.
0:44:11 We leaned into it a little bit and sent Barry and Daniel the flags, the all three flags
0:44:12 that hung outside.
0:44:13 The Swiss one included.
0:44:16 The Swiss one, the Swedish flag, and the US flag too, hung outside.
0:44:18 Thank you for joining the A6 and Zee podcast.
0:44:19 Thank you.