Looking to participate in a company's first stock offering to the public? Understand the differences between direct public offerings (DPOs), initial public offerings (IPOs), and Special-purpose acquisition companies (SPACs).
The market for newly public companies is constantly in flux. Sometimes investors are eager to dive into the next listing, and other times, they may shy away from new potential opportunities if they see too much risk.
Whether the market for new listings is hot or cold, investors interested in public offerings should learn exactly how companies can list and what each listing strategy entails. Initial public offerings (IPOs) use a broker, while direct public offerings (DPOs) offer a more direct approach. Both, however, are ways in which companies can sell shares for any reason.
Although DPOs are not as common as IPOs, each way of issuing shares comes with potential advantages and disadvantages for both the average investor and the company itself.
And then there are special-purpose acquisition companies (SPACs), aka “blank-check companies.” SPACs have been around for a long time, but they’ve become more popular in recent days after several high-profile SPAC success stories. Technically, though, a SPAC isn’t an alternative to an IPO or DPO. In general, investors access SPACs upon (or after) a public offering such as an IPO.
With that in mind, here are some of the differences between IPOs and DPOs (with a few “SPAC facts” sprinkled in).
The traditional way for companies to go public is through an IPO backed by at least one investment bank.
Institutional and other large investors typically have first access to the shares before the market open, and the general public is essentially a step behind them. So the average investor may miss out on any early gains from an IPO, whereas inside institutional investors can take full advantage.
With an IPO, an opening price is set beforehand, and the main goal is usually to raise outside capital. The underwriting process by an investment bank is usually longer than with a DPO, but the bank’s backing also provides the firm with an idea of how much capital will be raised before investors make a commitment for the offering.
Many of the largest public companies trading today opened to public trading through an IPO, including Alibaba (BABA), Visa (V), and Facebook (FB)—which were among the largest IPOs of all time.
Direct public offerings, also known as direct listings, are not as common as IPOs, but some companies prefer this strategy when issuing shares. That’s partly because they can avoid underwriting costs. Also, some experts believe a direct listing can offer greater liquidity and better price discovery.
With DPOs, companies may have more control over the terms of their offerings because they aren’t working with an investment bank to issue shares. As a result, all investors have equal access to the shares (instead of some investors getting early access, as with IPOs). The price of shares at the open is determined purely by the market instead of a preset price.
Instead of aiming to raise new outside capital, a DPO allows current owners to convert their stakes into stock they can sell. Because companies avoid the underwriting process, a direct listing is usually faster and less expensive.
Of course, the flip side is that these offerings don’t provide the backing of a financial institution. They can sometimes have more volatile outcomes once the stock starts trading. Several well-known companies, such as tech firms Slack Technologies (WORK) and Spotify Technology (SPOT) opted to skip the IPO process for the DPO approach when they opened to public trading.
A SPAC is a company in the developing stage—with no real business plan, other than to engage in a merger or acquisition within a specific time frame. It’s essentially a pool of funds created to buy another company (similar in fashion to many private equity funds). SPACs are designed to be flexible, if not a bit secretive. Specific targets aren’t required to be identified and, unlike a traditional IPO, underwriters don’t undergo thorough due diligence prior to the public offering of a SPAC.
But the risks don’t stop there. Per Securities and Exchange Commission (SEC) rules, a SPAC must typically complete an acquisition within 18 to 24 months and must use at least 80% of its net assets for any such acquisition. If it fails to do so, it must dissolve and return to its investors their “pro-rata” share of assets in escrow.
So what’s the allure? Sure, SPACs are highly speculative, but the lower regulatory bar can dramatically shorten the time it takes to get funding. In a disruptive, fast-growing industry such as electric vehicles and related technologies, a SPAC can help more speculative-focused investors get in at or near the ground floor. Just please, do your homework before jumping in.
Whether you invest in a newly listed company through an IPO or a DPO, there are several potential risks and benefits to consider.
On the plus side, IPOs and DPOs that succeed can offer investors a rapid rate of return as the market determines the company’s value. For example, shares of Zoom Video (ZM) doubled on its April 2019 IPO and then chopped along awhile, but shares took off to the upside in the 2020 coronavirus-related “stay-at-home” economy.
However, newly public companies sometimes see shares tank on their debut. In the case of social media giant Facebook (FB), shares crashed in the months following its hyped 2012 IPO. It took a while, but eventually they came back and now trade several orders of magnitude above the IPO level.
When you consider investing in an IPO or DPO, remember to look beyond a company’s brand and consider its business operations. Just because you like a company’s product doesn’t necessarily mean the stock is a good investment. Make sure you know the key financial metrics: the company’s debt, profit, and revenue trends.
Newly public companies tend to perform better when the overall market is doing well and less impressively when the broader market slumps. These investments can be riskier than others, so it’s important to strive for diversity in your portfolio to help reduce risk.
Still, IPOs and DPOs—and even SPACs—have the potential to offer significant returns, which makes them an interesting idea to consider for many investors.
Even though companies with new offerings won’t have a lengthy history of public information available to investors, you should still be able to learn about key financial metrics before you buy.
A detailed prospectus becomes available before a DPO or IPO, and much of the information in it should be relatively easy for even a nonexpert investor to decipher. The main things to consider are the company’s outline of possible risks to its business model, as well as where it sees competition.
Investors also might want to see if the prospectus explains a path to profitability, assuming the company isn’t yet booking profits. One of the main complaints some analysts voice about certain IPOs is that they’re not sure how those companies can eventually profit.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Inclusion of specific security names in this commentary does not constitute a recommendation from TD Ameritrade to buy, sell, or hold.
All investments involve risk, including loss of principal. Past performance does not guarantee future results. There is no assurance that the investment process will consistently lead to successful investing.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, and a subsidiary of TD Ameritrade Holding Corporation. TD Ameritrade Holding Corporation is a wholly owned subsidiary of the Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2020 Charles Schwab & Co., Inc. Member SIPC.