Nasdaq Extends Direct Listings
The Nasdaq Stock Market currently has three tiers of listed companies: (1) The Nasdaq Global Select Market, (2) The Nasdaq Global Market, and (3) The Nasdaq Capital Market. Each tier has increasingly higher listing standards, with the Nasdaq Global Select Market having the highest initial listing standards and the Nasdaq Capital Markets being the entry-level tier for most micro- and small-cap issuers. For a review of the Nasdaq Capital Market listing requirements, see HERE as supplemented and amended HERE.
On December 3, 2019, the SEC approved amendments to the Nasdaq rules related to direct listings on the Nasdaq Global Market and Nasdaq Capital Market. As previously reported, on February 15, 2019, Nasdaq amended its direct listing process rules for listing on the Market Global Select Market (see HERE).
Interestingly, around the same time as the approval of the Nasdaq rule changes, the SEC rejected amendments proposed by the NYSE big board which would have allowed a company to issue new shares and directly raise capital in conjunction with a direct listing process. In other words, the NYSE proposed an IPO without an underwriter. Although it was not clear as to all of the aspects of the proposal that prompted the rejection, in late December the NYSE made some adjustments to the proposed rule change and resubmitted it to the SEC. The most significant adjustment would be to allow listings with a capital raise of $100 million, down from $250 million in the first proposal. To qualify for the direct listing, the total value of shares, including those previously outstanding and those sold in the direct listing process, would need to be $250 million or higher. As of the date of this blog, no SEC action has been taken on the latest proposal.
Direct Listings in General
In a direct listing process, a company completes one or more private offerings of its securities, thus raising money up front, and then files a registration statement with the SEC to register the shares purchased by the private investors. Although a company can use a placement agent/broker-dealer to assist in the private offering, it is not necessary. A company would also not necessarily need a banker in the resale direct listing process. A benefit to the company is that it has received funds much earlier, rather than after a registration statement has cleared the SEC. For more on direct listings, including a summary of the easier process on OTC Markets, see HERE.
Where a broker-dealer assists in the private placement, the commission for the private offering may be slightly higher than the commissions in a public offering. One of the reasons is that FINRA regulates and must approve all public offering compensation, but does not limit or approve private offering placement agent fees. For more on FINRA Rule 5110, which regulates underwriting compensation, see HERE. A second reason a broker-dealer may charge a higher commission is that there is higher risk to investors in a private offering that does not have an immediately available public exit.
The investors take a greater risk because the shares they have purchased are restricted and may only be resold if registered with the SEC or in accordance with an exemption from registration such as Rule 144. Oftentimes a company offers a registration rights agreement when conducting the private offering, contractually agreeing to register the shares for resale within a certain period of time. Due to the higher risk, private offering investors generally are able to buy shares at a lower valuation than the intended IPO price. The pre-IPO discount varies but can be as much as 20% to 30%.
Furthermore, most private offerings are conducted under Rule 506 of Regulation D and are limited to accredited investors only or very few unaccredited investors. As a reminder, Rule 506(b) allows offers and sales to an unlimited number of accredited investors and up to 35 unaccredited investors—provided, however, that if any unaccredited investors are included in the offering, certain delineated disclosures, including an audited balance sheet and financial statements, are provided to potential investors. Rule 506(b) prohibits the use of any general solicitation or advertising in association with the offering. Rule 506(c) requires that all sales be strictly made to accredited investors and adds a burden of verifying such accredited status to the issuing company. Rule 506(c) allows for general solicitation and advertising of the offering. For more on Rule 506, see HERE.
Accordingly, in a direct listing process, accredited investors are generally the only investors that can participate in the pre-IPO discounted offering round. Main Street investors will not be able to participate until the company is public and trading. Although this raises debate in the marketplace – a debate which has resulted in increased offering options for non-accredited investors such as Regulation A – the fact remains that the early investors take on greater risk and, as such, need to be able to financially withstand that risk. For more on the accredited investor definition including the SEC’s recent proposed amendments, see HERE.
The private offering, or private offerings, can occur over time. Prior to a public offering, most companies have completed multiple rounds of private offerings, starting with seed investors and usually through at least a series A and B round. Furthermore, most companies have offered options or direct equity participation to its officers, directors and employees in its early stages. In a direct listing, a company can register all these shareholdings for resale in the initial public market.
Like many tech companies, Spotify’s share price has been erratic, but as of the date of this blog is slightly higher than its initial listing price on the NYSE. However, in a direct listing there is a chance for an initial dip, as without an IPO and accompanying underwriters, there will be no price stabilization agreements. Usually price stabilization and after-market support is achieved by using an overallotment or greenshoe option. An overallotment option – often referred to as a greenshoe option because of the first company that used it, Green Shoe Manufacturing – is where an underwriter is able to sell additional securities if demand warrants same, thus having a covered short position. A covered short position is one in which a seller sells securities it does not yet own, but does have access to.
A typical overallotment option is 15% of the offering. In essence, the underwriter can sell additional securities into the market and then buy them from the company at the registered price, exercising its overallotment option. This helps stabilize an offering price in two ways. First, if the offering is a big success, more orders can be filled. Second, if the offering price drops and the underwriter has oversold the offering, it can cover its short position by buying directly into the market, which buying helps stabilize the price (buying pressure tends to increase and stabilize a price, whereas selling pressure tends to decrease a price).
Direct Listing on NASDAQ
A company seeking to list securities on Nasdaq must meet minimum listing requirements, including specified financial, liquidity and corporate governance criteria. Nasdaq listing Rules IM-5405-1 and IM-5505-1 set forth the direct listing requirements for the Nasdaq’s Global Market and Capital Market respectively. The Rules describe how the Exchange will calculate compliance with the initial listing standards related to the price of a security, including the bid price, market capitalization, the market value of listed securities and the market value of publicly held shares.
Like it previously did for the Global Select Market, Nasdaq is now providing a methodology for companies which have not been listed on a national securities exchange or traded in the over-the-counter market pursuant to FINRA Form 211 immediately prior to the initial pricing and which wish to list their securities to allow existing shareholders to sell their shares.
Direct Listings are subject to all initial listing requirements applicable to equity securities and, subject to applicable exemptions, the corporate governance requirements set forth in the Rule 5600 Series. In addition to setting forth the method for determining initial listing requirements based on the price of a security, including the bid price, market capitalization and market value of publicly held shares, the new rules require that a listing can only be completed upon effectiveness of a registration statement that solely registers securities for resale by existing shareholders (i.e., no new shares may be registered).
The rule changes will also clarify that an IPO Cross can be used for the initial pricing of such securities. An IPO Cross is a methodology for the initiation of trading of a security where there has been no underlying IPO. To allow for the IPO cross initial trading, a broker-dealer must serve in the role of financial advisor to perform the functions that an underwriter would perform in an IPO to initiate trading.
Under the amended rules, Nasdaq will determine a security’s price based on (i) a third party tender offer for cash; (ii) a sale between unaffiliated third parties; (iii) equity sales by the company; (iv) an independent valuation meeting specific standards; or (v) a valuation as determined by a private placement market. Both IM 54-5-1 and IM-5505-1 are identical on their substantive provisions for direct listing valuations. In order to be considered evidence of valuation under (i) – (iii), the transactions must be completed within the prior six months and be substantial in size representing sales of at least 20% of the market value of unrestricted publicly held shares requirement.
In addition, any affiliate involvement in the transactions must be less than 5% per affiliate or 10% total, must have been suggested or required by a non-affiliate, and the affiliate must not have participated in negotiations.
Any valuation used for this purpose must be provided by an entity that has significant experience and demonstrable competence in the provision of such valuations. The valuation must be of a recent date as of the time of the approval of the company for listing and the evaluator must have considered, among other factors, the annual financial statements required to be included in the registration statement, along with financial statements for any completed fiscal quarters subsequent to the end of the last year of audited financials included in the registration statement. Nasdaq will consider any market factors or factors particular to the listing applicant that would cause concern that the value of the company had diminished since the date of the valuation and will continue to monitor the company and the appropriateness of relying on the valuation up to the time of listing. Nasdaq may withdraw its approval of the listing at any time prior to the listing date if it believes that the valuation no longer accurately reflects the company’s likely market value.
(f) A valuation agent shall not be considered independent if:
(1) At the time it provides such valuation, the valuation agent or any affiliated person or persons beneficially own in the aggregate as of the date of the valuation, more than 5% of the class of securities to be listed, including any right to receive any such securities exercisable within 60 days.
(2) The valuation agent or any affiliated entity has provided any investment banking services to the listing applicant within the 12 months preceding the date of the valuation. For purposes of this provision, “investment banking services” includes, without limitation, acting as an underwriter in an offering for the issuer; acting as a financial adviser in a merger or acquisition; providing venture capital, equity lines of credit, Popes (private investment, public equity transactions), or similar investments; serving as placement agent for the issuer; or acting as a member of a selling group in a securities underwriting.
(3) The valuation agent or any affiliated entity has been engaged to provide investment banking services to the listing applicant in connection with the proposed listing or any related financings or other related transactions.
For a security that has had sustained recent trading in a private placement market prior to listing, Nasdaq will determine a company’s price, market value of listed securities and market value of unrestricted publicly held shares based on the lesser of: (i) the value calculable based on the valuation calculated in accordance with the standards listed above and (ii) the value calculable based on the most recent trading price in a private placement market.
For purposes of the rule, a private placement market is one that is operated by a national securities exchange or a registered broker-dealer. Nasdaq will examine the trading price trends for the stock in the private placement market over a period of several months prior to listing and will only rely on a private placement market price if it is consistent with a sustained history over that several-month period evidencing a market value in excess of Nasdaq’s market value requirement.
For a security that has not had sustained recent trading in a private placement market for a period of several months prior to listing, Nasdaq will determine that such company has met the market value of publicly held shares requirement if the company has a valuation, as calculated via the above methods, in excess of 200% of the otherwise applicable requirement. For example, to list on the Nasdaq Global Market the valuation (if not gleaned from a private placement market) will need to be at least $8 per share. Likewise, each of the liquidity calculations will need to exceed 200% of the regular listing requirement.
Furthermore, if Nasdaq determines that the valuation evidence required by IM 5405-1 and IM-5505-1 is not reliable, Nasdaq will require evidence, including a review of all facts and circumstances, that the various valuation and pricing requirements exceed 250% of the listing standards. The rule release reminds companies that Nasdaq has broad discretion over the listing process and may deny an application, even if the technical requirements are met, if it believes such denial is necessary to protect investors and the public interest. I suspect that Nasdaq will carefully review any applications for a direct listing.
Foreign Exchange Listings
Where a company is transferring from, or seeking to dual list on, Nasdaq from a foreign exchange where there is a broad, liquid market in the securities, Nasdaq will consider the value based on the recent trading price in the foreign market.