Companies can hold a public offering either directly or through a broker. Direct public offerings (DPOs) have several significant differences from initial public offerings (IPOs).
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.
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) 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.
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, Beyond Meat (BYND), a producer of plant-based meat substitutes, saw shares surge more than 550% in the month following its IPO in May 2019, although it’s leveled off since.
However, newly public companies sometimes see shares tank on their debut. In the case of social media giant FB, shares crashed in the months following its hyped 2012 IPO. It took a while, but eventually they came back and now trade well 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 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 the IPO or DPO, 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.
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