The rules related to direct listings continue to evolve as this method of going public continues to gain in popularity. The last time I wrote about direct listings was in September 2020, shortly after the SEC approved, then stayed its approval, of the NYSE’s direct listing rules that allow companies to sell newly issued primary shares on its own behalf into the opening trade in a direct listing process (see HERE). Since that time, both the NYSE and Nasdaq proposed rules to allow for a direct listing with a capital raise have been approved by the SEC.
The Nasdaq Stock Market 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 listing standards, see 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 (see HERE). As previously reported, on February 15, 2019, Nasdaq amended its direct listing process rules for listing on the Market Global Select Market (see HERE). In May 2021, the SEC finally approved Nasdaq’s proposed rules to allow for a concurrent IPO and direct listing without the use of an underwriter (previously direct listings were only available for secondary offerings by existing shareholders). The very handy Nasdaq Initial Listing Guide now also includes the direct listing financial and liquidity requirements for the Nasdaq Global Market and Nasdaq Capital Market.
Direct Listings in General
Traditionally, 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 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.
A direct listing could also be associated with a spin-off of a subsidiary or division of a listed company, such as the current planned spin-off of Johnson & Johnson’s consumer health division and the spin-off by GE into three separate public companies.
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.
Early investors take a greater risk because there is no established secondary market or clear exit from the investment. Even where an investment is made in close proximity to an intended going public transaction, due to the higher risk, the 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%.
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 last amendments, see HERE and 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.
In a direct listing, there is a chance for an initial dip in trading price, as without an IPO and accompanying underwriters, there will be no price stabilization agreements. Usually price stabilization and after-market support is achieved, at least partially, 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 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).
The NYSE and Nasdaq rules now allow a company to sell shares directly into the trading market and thus complete a capital raise at the same time as its going public transaction. In essence, this direct listing hybrid is an IPO without an underwriter.
Nasdaq Direct Listing Process with Capital Raise
On May 19, 2021, the SEC approved Nasdaq’s proposed rule change to permit direct listings with a concurrent capital raise without an underwriter. Nasdaq calls the process a “Direct Listing with a Capital Raise.” Soon after the SEC’s approval, Nasdaq proposed an amendment to the rule to revise the pricing parameters for new direct listings with a capital raise. As of the time of this writing, the SEC has issued an order seeking comments on the modifications in which order it raises several issues with the proposed rule change.
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-5315-1, IM-5405-1 and IM-5505-1 set forth the direct listing requirements for the Nasdaq’s Global Select, 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.
New Listing Rule IM-5315-2 has been added to permit a company to list in connection with a primary offering in which the company will sell shares itself in the opening auction on the first of trading. A Direct Listing with a Capital Raise can only be accomplished in connection with a listing on Nasdaq’s Global Select market. The Direct Listing with a Capital Raise process also amended Rule 4702 to add a new order type – i.e., the Company Direct Listing Order, which will be used during the Nasdaq Halt Cross for the shares offered by the company in a Direct Listing with a Capital Raise. Finally, Rules 4120(c)(9), 4753(a)(3) and 4753(b)(2) were amended to establish requirements for disseminating information, establishing the opening price and initiating trading through the Nasdaq Halt Cross in a Direct Listing with a Capital Raise.
To qualify for a Direct Listing with a Capital Raise, the company’s unrestricted publicly held shares before the offering, plus the market value of 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) (as opposed to the IPO value of $45 million), with the value of the unrestricted publicly held shares and the market value being calculated using a price per share equal to the lowest price of the price range established by the company in its S-1 registration statement. As discussed further below, it is this pricing provision that Nasdaq is now seeking to amend.
Officers, directors or owners of more than 10% of the company’s common stock prior to the opening auction may purchase shares sold by the company in the opening auction, provided that such purchases are not inconsistent with general anti-manipulation provisions, Regulation M, and other applicable securities laws. However, shares held by these insiders are not included in calculations of publicly held shares for purposes of exchange listing rules except that, with respect to a Direct Listing with a Capital Raise, all shares sold by the company in the offering and all shares held by public holders prior to the offering will be included in the calculation of publicly held shares, even if some of these shares are purchased by inside investors.
Of course, any company seeking to complete a Direct Listing with a Capital Raise must satisfy all other requirements for a listing on the Nasdaq Global Select market, including having 450 unrestricted round lot stockholders (stockholders that hold more than 100 shares) with at least 50% of such round lot holders each holding unrestricted securities with a market value of at least $2,500 and 1.25 million unrestricted publicly held shares outstanding at the time of listing. In a Direct Listing with a Capital Raise process, the requirements must be fully satisfied on the first day of trading. That is, there is no grace period as is the case in a traditional IPO process. For a review of the Global Select Market direct listing requirements, including related to direct listings, see HERE.
In considering the initial listing of a company in connection with a direct listing in general, Nasdaq will determine that such company has met the applicable Market Value of Unrestricted Publicly Held Shares requirements based on the lesser of: (i) an independent third-party valuation of the and (ii) the most recent trading price for the company’s common stock in a Private Placement Market where there has been sustained recent trading. For a security that has not had sustained recent trading in a Private Placement Market prior to listing, Nasdaq will determine that such Company has met the Market Value of Unrestricted Publicly Held Shares requirement if the Company satisfies the applicable Market Value of Unrestricted Publicly Held Shares requirement and provides a Valuation evidencing a Market Value of Publicly Held Shares of at least $250,000,000.
In a Direct Listing with a Capital Raise, the market is informed of the minimum price at which the company can sell shares as it is included in the company’s registration statement. Accordingly, in a Direct Listing with a Capital Raise, Nasdaq will calculate the value of shares, including those being sold by the company and those held by public shareholders immediately prior to the listing, using a price per share equal to the lowest price in the price range disclosed by the issuer in its registration statement. Nasdaq will use the same price per share in determining whether the company has met the applicable bid price and market capitalization requirements based on the same per share price.
As noted above, a Direct Listing with a Capital Raise would allow the company to sell shares in the opening auction on the first day of trading on the exchange. To effectuate this, Nasdaq amended Rule 4702 to create a new order type called a Company Direct Listing Order (CDL Order). While there are many granular details about the CDL Order in the final rules, the most important concept is that the CDL Order is a market order which is entered without a price so the price will be determined by the Nasdaq Halt Cross, or the opening auction. Also, (i) the price must be at or above the lowest price and at or below the highest price of the price range set forth in the company’s S-1 registration statement; and (ii) the full quantity of the order (i.e., the total number of shares that the company seeks to sell in the Direct Listing with a Capital Raise) must be sold within that price range. If there is insufficient buying interest and Nasdaq is not able to price the auction to satisfy the CDL Order, the shares would not begin trading.
As noted above, in late June 2021, shortly after the SEC finally approved Nasdaq’s new Direct Listing with a Capital Raise, Nasdaq proposed a rule change to the price range limitations. In particular, Nasdaq has proposed to modify the pricing range limitation such that a Direct Listing with a Capital Raise can be executed in the Cross at a price that is at or above the price that is 20% below the lowest price and at or below the price that is 20% above the highest price of the price range established by the company in its effective registration statement. Nasdaq also proposes to modify the Pricing Range Limitation such that a Direct Listing with a Capital Raise can be executed in the Cross at a price above the price that is 20% above the highest price of such price range, provided that the company has certified to Nasdaq that such price would not materially change the company’s previous disclosure in its effective registration statement. The SEC has not approved the proposed change and has pointed out many issues with the proposal. I suspect Nasdaq will continue to tweak the request to the SEC’s satisfaction.
NYSE Direct Listing Process with Capital Raise
A company that seeks to list on the NYSE must meet all of the minimum initial listing requirements, including specified financial, liquidity and corporate governance criteria, a minimum of 400 round lot shareholders, 1.1 million publicly held outstanding shares and a $4.00 share price. Direct listings are subject to all initial listing requirements applicable to equity securities and as such, in a direct listing process, the rules must specify how the exchange will calculate compliance with the initial listing standards including related to the price of a security, comprising the bid price, market capitalization, the market value of listed securities and the market value of publicly held shares.
In order to qualify for the NYSE big board in a direct listing process, a company must have a minimum of $100 million aggregate market value of publicly held shares. In contrast, in an IPO, a company is only required to have a market value of publicly held shares of $40 million. The reason for the much higher standard in a direct listing process is a concern related to the liquidity and market support in an opening auction process without attached underwriters.
The NYSE rules allow a company to sell shares directly into the market, without an underwriter, as part of a direct listing process. In order to accomplish this, the NYSE created a new process dubbed an Issuer Direct Offering (IDO). To get the process across the finish line, the last amendment to the proposed rule (i) deleted a provision that would provide additional time for companies completing a direct listing to meet the initial listing distribution standards; (ii) added specific provisions related to the concurrent selling security holder and IDO process; (iii) added provisions related to participation in the direct listing auction when completing an IDO; and (iv) removed references to direct listing auctions in the rule related to Exchange-Facilitated Auctions.
The material aspects of the final NYSE direct listing rule (i) modifies the provisions relating to direct listings to permit a primary offering in connection with a direct listing and to specify how a direct listing qualifies for initial listing if it includes both sales of securities by the company and possible sales by selling shareholders; (ii) modifies the definition of “direct listing”; and (iii) adds a definition of “Issuer Direct Offering (IDO)” and describes how it participates in a direct listing auction.
To clarify the difference between an IDO and selling security holder process, the NYSE has defined a shareholder-resale process as a “Selling Shareholder Direct Floor Listing.” A pure Selling Shareholder Direct Floor Listing occurs where a company is listing without a related underwritten offering upon effectiveness of a registration statement registering only the resale of shares sold by the company in earlier private placements.
The Selling Shareholder Direct Floor Listing process retains the existing standards for direct listing and how the NYSE determines company eligibility, including the market value of publicly held shares. In particular, a company can meet the $100 million market value of publicly held shares requirement using the lesser of (i) an independent third-party valuation; and (ii) the most recent trading price of the company’s common stock in a trading system for unregistered securities that is operated by a national securities exchange or a registered broker-dealer (“Private Placement Market”). In order to satisfy the $100 million valuation, the NYSE requires that the independent valuation comes in at a market value of at least $250 million. In addition, the NYSE will only consider the Private Placement Market price if the equity trades on a consistent basis with a sustained history of several months, in excess of the market value requirement. Shares held by directors, officers or 10% or greater shareholders are excluded from the calculation.
An IDO listing is one in which a company that has not previously had its common equity securities registered under the Exchange Act, lists its common equity securities on the NYSE at the time of effectiveness of a registration statement pursuant to which the company would sell shares itself in the opening auction on the first day of trading on the Exchange in addition to, or instead of, facilitating sales by selling shareholders. This process is being called a “Primary Direct Floor Listing.” In a Primary Direct Floor Listing, a company can meet the $100 million market value of publicly held shares listing requirement if it sells at least $100 million in market value of shares in the NYSE’s opening auction on the first day of trading. Alternatively, where a company will sell less than $100 million of shares in the opening auction, the NYSE will determine that the company has met its market value of publicly held shares requirement if the aggregate market value of the shares the company will sell in the opening auction on the first day of trading and the shares that are publicly held immediately prior to the listing is at least $250 million. In that case, the market value is calculated using a price per share equal to the lowest price of the price range established by the company in its registration statement.
In order to facilitate the direct sales by the company, the NYSE has created a new type of buy-sell order called an “Issuer Direct Offering Order (IDO Order)” which would be a limit order to sell that is to be traded only in a Direct Listing Auction for a Primary Direct Floor Listing. An IDO Order is subject to the following: (i) only one IDO Order may be entered on behalf of the company and only by one member organization; (ii) the limit price of the IDO Order must be equal to the lowest price of the price range in the effective registration statement; (iii) the IDO Order must be for the quantity of shares offered by the company as disclosed in the effective registration statement prospectus; (iv) an IDO Order may not be canceled or modified; and (v) an IDO Order must be executed in full in the Direct Listing Auction.
A designated market maker effectuates the Direct Listing Auction manually and is responsible for setting the price (which involves many factors including working with the valuation financial advisor and the price set in the registration statement). The Direct Listing Auction and thus Primary Direct Floor Listing would not be completed if (i) the price is below the minimum or above the highest price in the range in the effective registration statement or (ii) there is not enough interest to fill both the IDO Order and all better priced sell orders in full. In other words, a Primary Direct Floor Listing can fail at the finish line. To provide a little help in this regard, the NYSE has provided that an IDO Order that is equal to the auction price, will receive priority over other buy (sell) orders.
The NYSE has also added provisions regarding the interaction with a company’s valuation or other financial advisors and the designated market maker to ensure compliance with all federal securities laws and regulations, including Regulation M. To provide an additional level of investor protection, and to satisfy the SEC, the NYSE retained FINRA to monitor compliance with Regulation M and other anti-manipulation provisions of the federal securities laws and NYSE rules. Finally, the NYSE made several changes to align definitions and rule cross-references with the new provisions and direct listing process.
In passing the rule, the SEC noted that after its several modifications, they were satisfied that the final rule helped ensure that the listed companies would have a sufficient public float, investor base, and trading interest to provide the depth and liquidity necessary to promote fair and orderly markets.